How To Invest In Trust Deeds

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2 How To Invest In Trust Deeds 2010, NoteWorthy Educational, LLC. P. O. Box New Orleans, LA Voice: Visit the NoteWorthy Newsletter web site at: This book is dedicated to the community of professional note brokers and institutional investors, whose support has allowed NoteWorthy to continue providing educational materials to this unique and uniquely wonderful business. All rights reserved. No part of this book may be used or reproduced in any manner whatsoever without written permission from NoteWorthy Publications, Inc. except in the case of brief quotations embodied in critical articles and reviews. For more information, contact NoteWorthy at the address above. COPYRIGHT 2010 NoteWorthy Educational, LLC., December 2010 All rights reserved This book is for instruction only, and is intended to provide accurate information. Some of the strategies discussed in this book may not be available from institutional note buyers, and some may be subject to change. This book is offered with the understanding that the publisher and the author are not engaged in rendering legal, accounting, tax or other professional services to its readers. If legal or other assistance is required, the services of a competent professional should be obtained.

3 Liability/Warranty: The author has made every attempt to provide the reader with accurate information. This information is presented for information purposes only. The author makes no claims that using this information will guarantee the reader personal or business success. The discussion of websites, laws, procedures and other information contained in this book are current as of the date of publication. The author shall not be liable for any loss or damage incurred in the process of following advice presented in this book.

4 Table of Contents Legal Statement Error! Bookmark not defined. Table of Contents 4 Introduction 6 Chapter 1 11 What Trust Deed Investing Is 11 General Overview of Trust Deed Investing 12 Chapter 2 15 The Basics of Trust Deeds 15 The difference between trust deeds and other investment types 16 Chapter 4 21 Typical Borrowers 21 Chapter 5 24 Legal Issues for Investors 24 Real Estate Law 24 TILA - Section Chapter 6 27 Loan Underwriting 27 Loan-to-Value 28 Borrowers 28 Chapter 7 31 Title Insurance 31 Chapter 8 36 Collection and Distribution of Loan Payments 36 Chapter 9 40 Lien Priority 40 Chapter Loan Documents 43 Information Regarding Notes 45 Construction Loans 46 Chapter Escrow 50 Escrow instructions 51 Important facts about escrow to keep in mind 52 Closing Escrow 55

5 Chapter Loan Enforcement 57 Foreclosure 58 Bankruptcy 61 Chapter Pitfalls for Investors to Watch For 63 Chapter Frequently Asked Questions 66 Conclusion 70

6 Introduction Today there are a number of ways in which investors can invest their money. From the stock market to savings bonds to deeds of trust, there is something for every investor looking for a way to grow their money. While most investments are made with the same end in mind, the main difference between each investment type are the strategies and the level or risk involved. However, although there is always some degree of risk involved when making an investment, trust deeds happen to be one of the safest investments available today, because unlike other investments, a trust deed is secured by actual property homes, buildings and land. Aside from the security of real property, with a trust deed investment, the other advantage is the investor receives higher than average rates of return. This is due to the fact that borrowers are willing to pay a higher interest rate because private investors are flexible with their loans, as they are not limited by traditional rules of bank loans. Without the constraints of such rules, private investors can provide quicker loans that do not follow the same rules as is required for traditional lending. Furthermore, deeds of trust are safe investments because borrowers are generally a good risk to take. The following are two excellent reasons why:

7 1. The borrower could loose their property (home, land, etc.) if they fail to pay the loan. 2. If the appropriate research has been done, the investment will have a more than sufficient loan to value (LTV) ratio. In other words, the loan amount is exceeded by the real property value. Why do I want to get involved with trust deed investing? At some point in your life you will retire, and like many other investors out there, you may be thinking about investing as part of your retirement plan. Trust deed investors who invest for their retirement agree that it is the best investment they can make, because a trust deed can earn 10%, which is as much as 5 times more retirement income compared to other investing methods such as a savings account which on average pays between 2-4%. Furthermore, investing in trust deeds for your retirement is safer than running the risk of being stuck in a low yielding mutual fund, or a bad stock. Another reason to consider is trust deed investors that plan for their upcoming retirement (whether it is IRA, KEOGH, etc.), know that by compounding an annual 10% interest through trust deed investments, they have the chance to take years off the necessary time required to reach the target date they have personally set for their retirement.

8 Need further proof why trust deed investing is the better way when it comes to making an investment for your retirement plan? Take a look at the following examples: Retirement plan without a trust deed investment Mary places $ in her IRA at 2.5% compounded annually. After 20 years, the $ would become $819.31, paying approximately a $17.00 annual retirement income to Mary at 2.5% (Note: This is calculated by using any handheld calculator. Begin by taking the percentage, in this case [1.025: 1 = the single deposit of $ and.025 = the 2.5% annual yield.] and multiply this number by $ Tap the equal button 20 times in order to compound the 20 years.) With a Trust Deed Investment James places $ in a 1 year trust deed investment that pays 10% compounded annually. After 20 years, the $ would become $ paying approximately a $ annual retirement income to James at 10%. (Note: this is calculated by using the same method as the previous example, except that the 10% is calculated as 1.1 [1.1: 1 = the single deposit of $ and.1 = the 10% annual yield.] By comparing the above two examples, James s trust deed investment provided him with approximately 15 times more retirement income! Now that s a difference worthy of your attention.

9 In addition, there are a number of other bonuses related to trust deed investing that you may want to keep in mind before choosing just any type of investment. Here are a few of the basic advantages that investing in trust deeds offers you as an investor: 1. The interest rate paid by the borrower is typically higher than rates paid by banks. 2. Investing in a deed of trust generates a monthly income that is established through interest payments. 3. Trust deeds can be traded 4. Trust deeds sell fairly easy because they are liquid 5. When you invest in a trust deed, every month that goes by increases your protection because the loan amount continues to be lowered by amortization. The more you learn about trust deeds, the more you will discover that this investment offers you a high rate of return at a risk you can afford. The purpose of this book Trust Deed Investing- is to provide you with the fundamentals of trust deed investments. Within its pages you will discover all of the essential aspects that are required in order to make investing in a deed of trust a secure

10 and safe risk taking experience. Some of the topics you will find include the different methods for investing, loan underwriting, title insurance, lien priority, escrow and much more. This book has been designed to give you a good idea of the many golden opportunities that await you should you choose to invest in deeds of trust. With all of the knowledge you will obtain from Trust Deed Investing, you will gain the confidence you need to know how to protect your investment, choose the right broker and provide an excellent product with the least amount of risk.

11 Chapter 1 What Trust Deed Investing Is The funds for these short term loans that are provided by various lenders come from a variety of sources that include, but are not limited to, individual investors, hedge funds, pension plans, trusts, IRA s, and REIT s. This type of lending is provided by Funders is commonly referred to as hard money or private money lending. What is private money lending? At this point you may be asking yourself: What is private money lending? Private money lending refers to loans that have been collateralized by real estate, and are made in regards to the decision of making a loan that is based mainly on the protective equity within the property. Private money loans are required by borrowers, who fail to meet guidelines set up by conventional institutions such as banks, life insurance companies and conduits. The guidelines regarding the main credit decisions of such institutions are based on the borrower s income and credit. Thus, from a lenders perspective, while providing a loan may seem like a sensible transaction, due to the fact that it s classified as subprime, it requires private money lending.

12 A Private Funder underwrites, solicits, processes and funds private money lending, and is extremely reliable because they have experience in real estate lending. They are experts in their field, and provide creative financing solutions because they know how to deal with, and understand complex transactions. Their creative skills give them a unique advantage over other lenders, because they provide direct loans that are underwritten. In other words, instead of outsourcing to obtain their information, the Lender personally determines inherent risks regarding specific loans, and establishes appropriate terms and conditions for the loans which they fund internally. This allows them the ability to approve and fund loans within hours or days of a submitted application. General Overview of Trust Deed Investing Private funders provide investors with many unique opportunities to invest in trust deeds. The loans provided by them are first secured with deeds of trust on real estate, and in addition are supported with the borrower s personal guarantee. All deeds of trust are insured by a reputable Title Insurance Company that is recognized nation wide, and all costs that are related to underwriting, documentation and servicing of the loan are paid by the borrower. As an asset based lender, they primarily base their decision on whether or not to provide a loan based on the amount of equity in the property. If the property meets their

13 equity requirements, a Funder will then carefully analyze the borrower s personal characteristics, as well as their ability to repay the loan, and the project viability. Before a loan is granted, a Funder s officer will perform a personal inspection of all subject properties. Furthermore they will never fully rely on appraisals, and will confirm values by utilizing their own internal comparable sales analysis through an interviewing process with real estate brokers familiar with the area in question. The vast majority of loans that are funded by private lenders are through individual investors. Every investor is provided with a loan summary that supplies information in regards to: loan terms Property serving as collateral Details about the borrower/guarantor A good private funder gives support to their investors, and assists them through every stage of the loan, which includes the documentation, servicing and loan management.

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15 Chapter 2 The Basics of Trust Deeds At this point you know that a trust deed is one of the safest investments you can make that offers you a high return, but what exactly is a trust deed? A trust deed, or deed of trust is a document that is used to secure the debt on a home acting as a mortgage. A trust deed is recorded as a lien on real property. However, although a deed of trust acts like a mortgage, it is important that you understand there are differences between a mortgage and a deed of trust. These differences will be discussed later on in this chapter. A trust deed is used as security for a loan on real property, and the specifics regarding the loan are written in a promissory note. A deed of trust is then documented at the county recorder s office to legally notify the world that the property in question has now been pledged to secure a loan. There are three parties involved in a trust deed: 1. Beneficiary Investor/Lender/note holder

16 2. Trustor Borrower 3. Trustee Third party selected by the investor who has the legal power to act on the investors behalf and hold title until the note has been paid. What secures a trust deed investment? When making a trust deed investment, the deed of trust recorded against the borrower s property title is what secures the lenders investment. When making an investment in a deed of trust, the trustor (borrower) makes the property transfer, in trust, to the trustee (independent third party). The trustee then holds the conditional title on the behalf of the beneficiary (investor/lender/note holder), and then either of the following takes place: 1. The trust deed will be returned to the borrower once they satisfy all of the terms and conditions that were outlined in the promissory note 2. The property will be put up for sale should the borrower default also known as foreclosure. Foreclosure is the process that is taken by the investor in order to sell the property to a bidder from a third party, or to obtain title to the property. Usually the foreclosure sale satisfies the debt that is owed to the investor. The difference between trust deeds and other investment types

17 What is the difference between a mortgage and a deed of trust? The following are the basic differences between a mortgage and a deed of trust: Only two parties are involved in a mortgage document - the lender and the borrower. Three parties are involved in a trust deed the lender, the borrower and the trustee. With a mortgage document foreclosure the state law will determine the foreclosure method that will take place, which can sometime involve a lengthily process. A deed of trust usually involves a quicker foreclosure, because the most common type of foreclosure is a non-judicial one. The different between investing in a deed of trust and the stocks The value of a stock fluctuate hourly, and sometimes by the minute. The value of a deed of trust is fixed and is always stable. An owner of stock is in third lien position.

18 The owner of a trust deed is generally first or second in regards to the lien position. Every stock investor is charged a fee from their stock broker. A trust deed broker often charges investors no fees. Stocks can be purchased and sold through brokers. Trust deeds, on the other hand, are purchased and sold through brokers, but can also be purchased and sold privately at no extra charge. The security position of the stock owner is shared among thousands of other holders. The security position of the owner of a trust deed is not shared with anyone. A is supported by conglomerate properties and equipment that are often from foreign countries (ex. warehouses, factories, port facilities, mills, ships, etc.). Deeds of trust are only collateralized by real estate that occurs within the U.S., and usually by homes that are within the local area of the investor.

19 A stock is a gamble. A trust deed is an investment

20 Although it is evident that there are many differences between trust deeds and other types of investments, one thing is for certain a trust deed is an investment opportunity that offers you a high return with less risk.

21 Chapter 4 Typical Borrowers There are a number of reasons why borrowers require private money loans. Some of these reasons could be, but are not limited to the following: Borrowers that need money quickly Borrowers who have lost bank loans because of excessive conditions, declines or any other reason Borrowers who do not want to waste their time undergoing the hassle of processing an institutional or bank loan Borrowers interested in ground up construction Borrowers who need a loan that has flexible conditions

22 Borrower has the opportunity to gain investment by utilizing the equity in their real estate. Borrower is a non-profit organization (ex: churches, charities, etc.) Borrower is in unfortunate circumstances that make it difficult for them to obtain bank assistance, circumstances such as: Poor credit Bankruptcy Irrevocable Trusts, etc. Tax Liens (estate, federal and state taxes, etc.) Other Liens (property taxes, judgment liens, etc.) Receivership or Foreclosure Property held in Trusts, Probate, etc. Divorce Unemployment Medical emergencies Etc. Borrower has property with certain characteristics that make it difficult for them to obtain a loan from the bank, characteristics such as:

23 A high vacancy-loan is required to increase the occupancy of the income property Partial construction of building or near completion Seismic retrofitting Property improvements Etc.

24 Chapter 5 Legal Issues for Investors When you invest in a trust deed there are certain legal issues that you need to consider. Regardless if you secure your trust deed investment through a single lender (whole) or by more than one lender (fractionalized), you will still need to follow certain rules and regulations as stated by real estate law. Real Estate Law The Real Estate Law includes what is commonly referred to as the multi-lender law. This multi-lender law has certain restrictions which it can impose on the investor. Some of these laws include, but are not limited to the following: The investor must have their loan serviced by a mortgage loan broker (MLB) and have a written agreement. Furthermore, the investor and the MLB need to arrange for a third party to take part in loan servicing. The third party should be a qualified, licensed real estate broker. A loan can have no more than 10 note holders or lenders.

25 The investor is not permitted to invest more than 10% of their annual income or net worth Based on the type of property that is considered collateral, defined loan-to-value ratios are not to be exceeded Only under limited circumstances is the MLB allowed to self-deal. The investor s loan is not permitted to be indirectly secured though any other deed of trust or promissory note, and is only secured directly through the property. TILA - Section 32 Aside from the Real Estate Law, you may find that your loan documents will feature another legal document known as the federal Truth-in-Lending Act (TILA). The TILA was amended in 1994 and was created in respect to loans that are secured by a borrower s principal property. The rules of the TILA affect all mortgage transactions that are described as having fees or rates that are above a specific amount or percentage. Such mortgage transactions are known as high rate/high fee or Section 32 loans. A loan that is considered to be high rate is one where the appraisal exceeds ten points on the Treasury Security yield that has similar development. A high fee loan, on the

26 other hand, is one where the total fees and points are greater than 8% of the total loan amount. If you have any questions concerning the TILA, you can contact the Federal Trade Commission, as the TILA regulations are enforced by them. As you can see there are many legal issues for investors to consider before they invest in a deed of trust. Make sure you understand all legalities concerning trust deeds before you make your investment.

27 Chapter 6 Loan Underwriting The underwriting discipline of the lenders is one of the single most important elements when investing in a trust deed. The reason why loan underwriting is so significant to trust deed investing is because part of the underwriting process is to determine the Loan-To-Value Ratio (LTV). The process of underwriting is what the lender goes through in order to qualify a borrower for a loan, and also makes certain that the loan has been properly documented and structured. The LTV if often determined though the comparison of the loan amount to the appraised value regarding the collateral that secures the loan. Throughout a loan transaction there tend to be far fewer problems when a loan has been properly underwritten. However, if problems do arise, the borrower is encouraged to set them right should they wish to protect their equity in the project. Almost any problem can be rectified; it s only a matter of money. In the event that the borrower fails to solve their problems, regardless of the reason, the loan s margin of equity proves to be helpful as it enables the lender to absorb the cost to solve whatever problems have occurred.

28 Loan-to-Value The loan-to-value principal is what makes carrying a high yield with a trust deed investment secure. The reason is because LTV means to loan a percentage of money that is less than the actual property value. When it comes to real estate lending, LTV is the single most important element, because an adequate LTV protects the initial investment, while a remaining cushion of equity helps to pay off any unexpected costs that may occur. When it comes to loan-to-value ratio, the goal of an investor should always be to try and keep the LTV at the lowest possible amount. For instance, a good rule of thumb that every investor should follow is to never have an LTV higher than 70%. Remember, the lower the number, the more equity the investor will receive on the property. For the most part, when lenders need to analyze a loan situation, they generally rely on appraisals in order to determine their loan-to-value ratio. Borrowers Another important aspect of the underwriting process is finding out how the borrower intends to refinance the loan in regard to the loan terms that have been specified in the promissory note. Typically, a lender should want to conduct business with a borrower who has a decent record.

29 The following is information the lender should take the time to find out about the borrower before distributing a loan, so that the loan can be underwritten accurately The address of physical property description. This includes the square footage of the land, the description of the building(s) or improvements, operating statements, rent rolls and income property. The property preliminary title report If it is a purchase, find out the purchase agreement Confirmation of the zoning letter issued by the city/county that confirms the zoning for the property. The corporate papers of the borrower Phase one environmental report If the loan happens to be funding a construction or rehabilitation project, the lender will also want to obtain the following criteria: Breakdown of the construction cost

30 Agricultural and engineering plans that have been fully approved Description and site plan of buildings/improvements on the site

31 Chapter 7 Title Insurance Title insurance is quite different from other types of insurance. Why? Because unlike other forms of insurance that provide coverage for unpredictable occurrences that could possibly happen in the future (such as life, health or casualty insurance), title insurance protects the party insured from loss that results due to events that happen before the effective date of the title insurance policy. Another important difference is that title insurance is a single premium product. This means that the buyer pays a one-time only premium for the lenders benefit on the day the policy is issued. The amount of the title policy premium is based on the amount of money that is being insured by the loan. A trust deed investor always needs a title insurance policy. How to obtain title insurance policy

32 A title company will open a standard insured loan transaction, and will research the property. When it comes to researching the property, the title company will begin from the time the government conveyed the property, and then move on to the original private owner, and continue on until the title company reaches the most recent record within its database. Once the title company has finished its examination of the property, the title agent will then share the results of the research with the investor, revealing the title condition. The report that is conducted by the title company is known as a preliminary report or a prelim. The prelim is created from an itemized list of exceptions (title facts). When it comes to preliminary reports, the most common exceptions include: Casements for a variety of purposes Real property taxes Any mineral uncertainties or the right to examine for them Covenants Any encumbrances or liens that presently affect the property Restrictions and conditions better known as CCR s. Policy Types

33 Although there are different title insurance policies, the most common ones that are used today are: 1. American Land Title Association (ALTA) This policy is generally issued to a lender who holds a deed of trust in first position. 2. California Land Title Association (CLTA) - This policy is generally issued to a lender in second position, or to the purchaser of a property. What is insured by policies? Although it may appear that each title insurance policy listed above appear similar, that ALTA policy is recognized as being far superior to the CLTA policy. The reason is because ALTA provides a broader range of coverage compared to CLTA. However, despite their differences, each policy works to insure some the following (Note: The list below is only a small sample of the insurance provided by these two policies): The deed of trust that is insured is recognized as a valid an enforceable lien. No defects, encumbrances, or recorded liens appear on the title. All that appears is what is displayed within the policy.

34 The right of access to and from the property The title to the property is made marketable Any assignment of the trust deed that is displayed in the policy is valid and enforceable. Even though each policy works in the best interest of the investor, ALTA is still considered to be the best choice among the two, and is something you should keep in mind when selecting a policy. Endorsements While some properties may look similar, you need to understand that no two pieces of land are the same. Different factors associated with each lot of land such as casements, CCR s, and location, make one piece of property different from the next. And depending on the results of these factors, they can determine if there is an unpleasant effect on title clarity and even on value. Due to the fact that there are so many diverse varieties of factors, additional forms of coverage have been continuously developed in forms of endorsement.

35 Endorsements are very similar to the riders found in a variety of other types of insurance, and they provide coverage for precise issues that are not covered in the preprinted title insurance policy. Title insurance, and the process that is associated with the creation of a title insurance policy, provides the investor with an in depth examination of the property title and everything that affects it. Ultimately, title insurance gives the investor reassurance that they are involved with a safe investment.

36 Chapter 8 Collection and Distribution of Loan Payments Loan servicing provides a great service to investors, because it allows a third party servicing officer to collect on a trust deed and a note on behalf of the investor. Not only is this an efficient means of collecting on a trust deed and a note, but it is more beneficial to the investor when there is a third party involved in the note and deed of trust, because the borrower simply has to make a single payment out to the servicing officer, instead of payments to multiple investors. The reason why this is beneficial to the investor is because the borrower is more likely to meet payments and not cause problems. Thus, when an investor makes the decision to involve a third party that is well established and reputable, the higher the chance that the borrower lives up to their end of the bargain as far as the loan is concerned. Third Party Benefits When a third party is involved, it becomes the loan servicing department s responsibility to bill the borrower for regular monthly payments. It is also their responsibility to enforce on the borrower the loan agreement terms, so they respond in a proper and timely manner.

37 There is no question that some borrowers will do everything in their power to try and avoid and delay making payments. Borrowers that create this type of problem can often be extremely difficult for an investor to deal with, especially if the investor is new to private money lending. That being the case, it is in the investor s best interest to loan through a third party that has the experience to deal with problem borrowers. The third party separates the investor from interaction with the borrower, relieving them of burdens and hassles which helps the investor feel more secure in their investment because the loan process is likely to run smoother. Borrowers know that when they receive a fast response from the third party in regards to their lack of payment, that the loan servicing department has zero tolerance for such behavior. Furthermore, in-house counsel will start foreclosure within 24 hours after a default has occurred on the loan. Therefore, borrowers will do everything they possibly can to avoid foreclosure, as it is extremely costly to them, and has the potential to damage their credit. A Third Party Produces Excellent Results

38 It is through strict and constant enforcement that reliable payment and performance is maintained. It is not uncommon for a borrower to try and convince, or pressure a lender to give some slack in regards to terms and due dates for payments. With a loan servicing department, a borrower knows that such possibilities won t happen, and that no other agreement will be tolerated save for the initial one that was created when the loan was issued. Loan Servicing The following is how a typical loan service is conducted. Each month, the loan servicing officer bills the borrower and collects payment, depositing the funds that are received into the account of the investor. Once the payment has been received in full, and the funds are cleared, the loan servicing officer will then begin to issue the appropriate checks to the investor(s) involved in the loan. At the same time every month, statements and a check that covers the interest earned throughout the month are mailed to the investor(s).

39 The servicing agent maintains the payment records, and for tax purposes, the investor will receive a 1099 form. If there is a default on the loan, the loan servicing officer may choose to start foreclosure. Should there be problems during the foreclosure, or should necessary negotiations need to take place during the process, in-house legal counsel is waiting to offer assistance to the investor. Lastly, should the foreclosure be stalled or halted by a borrower s bankruptcy petition, the in-house legal counsel will immediately try to relieve the stall or request the bankruptcy court provide sufficient protection. As you can see, using a third party when investing in a deed of trust acts in your best interest, and is something you should seriously consider before you decide to make a trust deed investment. And remember, make sure the loan servicing company you choose has experience, integrity and a good reputation.

40 Chapter 9 Lien Priority You may or may not be aware, but a deed of trust is actually a lien on a piece of real property. What is a lien? A lien is a legally recognized claim or hold against one person s item by another which utilizes this item as security for a duty, debt or obligation. If there is more than one lien on a piece of real property there could be a number of reasons for this. Some of the liens an investor may encounter include: Tax liens Mechanic s liens IRS liens Judgment liens Etc. A few interesting facts about liens

41 It is important for you to know that liens in first priority are the most ideal. Therefore, in order to obtain this priority, this needs to be verified before the closing of escrow. In order to obtain the accurate information that is required to verify the priority of the deed of trust, you will find that Title insurance policies will provide you with what you need to know. If it happens that an error is made, or a lien has been overlooked and such aspects affect the trust deed holder, then the holder can take legal action against the company that issued the title insurance policy. When the holder is in possession of the priority lien, they can foreclose and any junior lien holders won t be able to stop it. That being said, there are ways in which junior lien holders can protect themselves should this happen. To begin with, they can make certain that their lien has been accurately recorded with the county recorders office. They can also inform all senior lien holders about their lien, and ask them for written notification before they foreclose. Tax Liens Tax liens have priority over deeds of trust. This is a fact you won t want to forget should a tax lien appear. Thus, in order for the investor to protect themselves in the event of a tax lien, a provision should be added in the trust deed and note that explains if the

42 borrower and their property have or will receive a tax lien; it is the trustor s responsibility to contact the investor. In addition, the note should provide the investor with the choice of needing the payoff, so that they can protect their principal from foreclosing on the tax lien.

43 Chapter 10 Loan Documents There are different loan documents that secure an investment. However, regardless if you are loaning money on real property as security, or are investing in a deed of trust, the documents you would require for both are the same; you would require the trust deed and the note. The trust deed is what will secure the repayment of funds that are owed according to the conditions of the note, and will then become a lien on the property. The note, on the other hand, shows the initial amount that is owed based on the terms and conditions regarding the repayment of the trust deed. While all notes function with the same end in mind, there are different types of notes that can be obtained. The following is a list of notes: The Promissory Note - This is a common note, and as the name suggests, it is the borrower s written promise that they will pay a specified amount of money, installments of money, or money on demand to a named person, in the future, at any given time.

44 The Amortized Note - the amortized note is often used for real estate transactions. It requires that the borrower usually make regular monthly payments of interest and principal throughout the period of the loan. A Holder in Due Course Note This particular note is in reference to an individual who is the innocent buyer of the note for value, and was oblivious to any defects that existed within the note when purchased. The holder of this not is protected by the law, as they are considered to be in good faith holding this negotiable note. The Straight-Interest-Only Note The straight-interest-only note, is one that does not require payments of principal during the life of the loan. The interest payments are considered negotiable, but generally they occur as monthly payments. Recourse Note For this note, the endorser is making a guarantee that the payments will be given to the present holder, as well as all the other holders. That being said, a person may choose to recourse a note so that the payment goes to one individual in particular and no one else. As an endorser, one should be cautious when using this note, because the payment liability is extensive.

45 Note Without Recourse If this note is written above the signature it implies that future holders will not be guaranteed payments. The Demand Note This note is used only on special occasions and is subject to be called in at any time for full payment. An or more Note some notes feature an or more clause that is located near the payment amount. This or more clause enables the borrower to rightfully increase their monthly payments when they choose, as well as the right to fully pay off the loan without being subject to penalty. However, if both parties involved in the loan agree, the or more clause can be deleted by simply having an escrow agent omit the objection. Information Regarding Notes You need to understand that while some notes can be negotiable, others are not. In order for a note to have negotiability, the note must have the option of unconditional promise to pay, without contingency, which is based on the future actions of the borrower. A negotiable note must provide a set sum of money for the payment at a specific time, and must be payable to the holder. However, the vast majority of notes are transferable through endorsement.

46 What if a note is lost? If you lose a note, it will need to be replaced. The reason is because the original note is not a recorded instrument, like the trust deed. Thus, even if you have a copy of the original, it will not suffice because only the original note is considered to be the life of the transfer. Losing a note is a problem that is also quite costly. The best way to replace a note is for the two parties to come together and sign a new note. If this action can not be performed, it may become mandatory that you seek the service of an attorney. An action must be filed in court to reconstruct or restore the lost note. Although, in some cases, depending on the state, sometimes the issue of a lost note can be resolved by means of a lost note affidavit. In order to keep your original note and deed of trust safe, you should place them in a safety deposit box at your bank. However, make sure you make copies of both documents, so you can have them on hand, and refer to them later for future use. Construction Loans There are different construction loans that can be invested in. For instance there are:

47 Improvement and Renovation Construction Loan this loan is funded to enhance the value of property based on upgrades and modifications. Ground-up Construction Loan This loan is one that assumes the borrower has approvals and a completed set of plans which are sufficient so that construction can begin once the loan has been funded. With a lender approved draw schedule, the proceeds of the loan may be funded over a certain amount of time. Infrastructure Construction Loan - The proceeds for this loan are used to give the borrower the chance to develop and complete the infrastructures of the property, prior to the start of ground-up construction. The use of such loan proceeds can fund the installing of utilities, water pipers, sewers, streets, gutters, curbs and related utilities. With a construction loan, there are certain aspects that must be followed to ensure that everything goes according to plan. For instance, the lender needs to consider inspections and lines. Inspections to Protect Investment It is imperative that frequent inspections are conducted in order to protect the lenders investment. This protection is made possible

48 by the coordination of project funding with the lender. Through reviewing and maintaining plans, as well as specifications that are relevant to jobs. Furthermore, contracts are reviewed to make certain that borrowed funds are sufficient to complete the project. With this type of documentation at their disposal, the company in question can have complete control and account for construction funds from the start of the project until completion. Routine inspection reports of the construction site are prepared by an inhouse inspector. This report details items that have been completed and are still under construction. Preliminary Lien Notice With a construction loan, most states will require that a preliminary lien notice be sent to the lender, general contractor and owner before, or on labor services or material provided by the subcontractor/material supplier. Once this notice has been sent, the subcontractor has been given the right to lien a project. A construction control company that is well managed will ask each party involved to send their copies of all notices. The purpose of this procedure is so that those who supply the services and products, as well as those who are the subcontractors working on the project, can be tracked. Finally, when it comes to a construction loan, construction control is imperative to any construction project. Prior to the hiring of a control company, its disbursement policies

49 must be looked into. You need to understand that not every company functions the same. For instance, while some companies will consider themselves control companies, the actually disburse the funds directly to the owners or general contractor, without first making certain that the subcontractors and material suppliers have been paid. To be on the safe side, it is always in your best interest to ask whether or not a construction control company is used.

50 Chapter 11 Escrow When you fund a loan or purchase a promissory note, this transaction should be done through escrow. Escrow is a specific process in which a title of transfer and a funds transfer take place via a neutral third party during a real estate transaction. The company providing escrow acts as the middle person in the transaction, and the escrow agent is the one who will process the transaction in accordance to the initial escrow instructions that were agreed on by the lender and the borrower. The instructions provided by escrow determine the conditions that need to be met or waived before the escrow officer can take action and disburse your money to either the note holder or the borrower. Some of these conditions include, but are not limited to 1. Delinquent taxes are paid 2. Certain liens are removed 3. Choosing title insurance coverage 4. Completion and handing over of the deed of trust or promissory note, or the completion and handing over of the endorsement or assignment of the promissory note.

51 Escrow instructions Due to the fact that escrow usually involves the transfer of an investment in land, all conditions regarding the transfer need to be in writing. That being said, the following is a list of the criteria that is required to be stated within the escrow instructions: 1. Name of the escrow agent, third party or depository 2. Names of both the buyer and seller as well as their proper title (ex: joint partnership, corporation, individual person, and so on) 3. A legal description of the property that is to be transferred 4. The price at which the property was purchased 5. Set conditions in regards to transfer and payment 6. Distribution of cost, insurance costs, taxes and assessment 7. The signature of both the seller and buyer All of the transaction details, including the agreement made by the seller and buyer, need to be written in the escrow instructions so that it is clearly understood by all parties involved. Even promises made orally should be written down. When the instructions have been completed, it is then important for the investor to read the preliminary title report more than once to ensure that everything is understood and nothing has been overlooked or missing. The investor (you) should also check and see that the trust deeds and notes, as well as the amount of indebtedness are all in proper order.

52 If the investor has the first deed of trust, then there will be no other lien before theirs. Furthermore, the investor should also make it a point to ask questions in the event they discover certain wording or restrictions they fail to comprehend. Should this occur, the investor should ask the escrow agent to produce copies of the listed documents in the title report. As an investor, you should never feel embarrassed to ask questions. Remember, only through asking questions will you learn all the facts of purchasing a trust deed. Important facts about escrow to keep in mind Legal advice - Be advised that while an escrow company will assist you, escrow s purpose is not to provide advice on legal matters. Nevertheless, an investor may ask the advice of a broker or escrow company, and they may or may not tell the investor how a similar problem was resolved in past escrows. However, if an escrow involves tax and legal problems and is extremely technical, than the investor should seek the advice of an attorney. Casualty and Fire Insurance Insurance is imperative when it comes to making a trust deed investment; because as an investor you will want to ensure that you have sufficient insurance to protect your

53 investment. The investor should check with the escrow agent to ensure that when the close of escrow occurs, an endorsement will follow. Notice request A notice request must be placed in the agreement to make sure that the investor will be notified should a default action start on one of the previous loans. If in the event the investor held a second deed of trust, and the initial trust deed holder began a foreclosure action, the investor would receive notification. The reason why such foreclosure actions are started is due to the fact that payments on the promissory note have not been made, or it could be that taxes and insurance are overdue. Include important conditions Should a late charge be included as part of the note, the investor needs to ensure that the conditions regarding the late charge, are included in both the escrow instructions and the note. Acceleration Clause

54 An acceleration clause should be apart of the escrow documents. This clause indicates that full payment of the loan is required to be made upon liens, change of ownership or a transfer. Escrow number Should it become necessary in the future, for the investor to discuss a section of the escrow with the agent in charge, if the investor has the escrow account number it will be easier for the agent to locate the escrow file in question. Furthermore, it is in the investor s best interest to safely secure the escrow agent s card, and inset the escrow number on it. Thus, this will ensure that the investor has the escrow number, the name of the escrow company, as well as the name of the individual responsible for the documentation. To make things easier, investors should keep all loan escrow documents/papers in a single folder, and to ensure the protection of the original deed of trust and note, secure these documents in a place safe from theft, fire or other potential hazards that could lead to their loss. Finally, the investor should make copies of all the important documents (for example- escrow instructions, trust deed, promissory note), and keep them at home where they can be easily accessed and referred to when needed. Obtain certified copy of escrow papers

55 The investor needs to obtain a certified copy of escrow papers, which is an escrow file that has been verified and signed by an agent of the escrow company and is considered to be a valid and accurate copy of the original document. Once the investor has the certified copy, the escrow company recognizes that the investor expects all conditions and terms of the escrow to be completed precisely. A certified copy of escrow papers is especially important when it comes to cash transactions where the investor wants to ensure the trail of cash is carefully documented. Closing Escrow Once you have completed all of the necessary instructions and requirements for escrow, and it begins to take its normal course, you are now ready to close escrow which is often referred to as close of escrow, closing or settlement. Regardless of the term used, the closing of escrow is when all of the final papers are signed, and the closing officer is prepared to record the deed to the property, and the sale goes to the seller. The instructions for escrow that you will be requested to sign could be unilateral (separate set of instructions for the buyer and separate ones for the seller) or bilateral (one set of instructions for the seller and one for the buyer). Different areas use different methods. Those that use unilateral escrow instructions generally sign at the

56 end of the escrow term, while those that use bilateral escrow instructions usually draw up and sign in the initial opening of escrow. Be advised that once the escrow documents have been signed, if you try to cancel, regardless of the reason, you may be subject to penalties or even legal consequences. Therefore, it is imperative that you carefully read and re-read all the closing documents. Double check the documents for clerical or mathematical errors. Sometimes issues may arise that can cause a delay in the closing process, such as one party may be not be able to sign the papers at the closing time, because they are unavailable. Although this can be a problem, it is one that can be dealt with in several different ways such as: 1. The documents can be sent to the unavailable party ahead of time and presigned. 2. A power of attorney can be implemented to allow another individual to act on behalf of the absent party and sign for them. When everything is in the clear, and the documents have been appropriately signed, the escrow officer will inform the title company to record the trust deed, who will then deliver the loan package (all the executed loan documents) to the lender. As soon as the lender is in possession of these documents, they will then release to the title or escrow

57 agent their loan proceeds. The title attorney or escrow agent will ensure that the exchange of documents and funds runs smoothly. Thus, escrow closes when every condition of the escrow instructions have been met or waived, the documents have been recorded, and the funds have been released. A closing statement will be sent to you, which describes how and to whom the documents and funds were distributed. Chapter 12 Loan Enforcement While it is true that trust deed investing is one of the safer ways in which to obtain an excellent return on an investment, there is always the chance that the borrower may default. When a borrower fails to pay their debt or violates the agreement, there are ways in which the investor can remedy the situation. This remedy is a process known as foreclosure, and simply put; it is the process through which the property in question is sold in order to satisfy the debt owed to the lender. (Note: Keep in mind that each

58 state may have their own process of foreclosure, so the following information may not apply to your area) Foreclosure There are two types of foreclosure processes that are used in regard to trust deed investments: 1. Judicial Foreclosure this process is the more costly method and is when the courts are utilized to foreclose on the property, and an attorney is required. 2. Non-judicial Foreclosure This process is usually simple and fast, and is the one that is commonly used for trust deed investments. A non-judicial foreclosure can be handled by just about any title company or an independent foreclosure company that has a good reputation. When beginning the non-judicial foreclosure process, there are certain documents that the investor will be required to give the foreclosing officer. Some of these documents include the original or conformed copy of the recorded trust deed and the original note secured by the trust deed. In addition, the agent will request a written statement regarding the default amount, the date up to which the interest is paid, the due date of the payment, and the unpaid

59 principal balance. As soon as the officer obtains all of this information, they will then be able to organize the foreclosure documents and prepare for the process. Reasons why foreclosure is initiated There are a number of reasons for foreclosure, including both monetary and nonmonetary reasons. As far as monetary is concerned, the defaults include are as follows: Nonpayment of a balloon payment (when all the payment is due at one time) Nonpayment of a due monthly amount Advancements for each provision of the trust deed in regards to nonpayment of a senior lien, which would jeopardize the position of the foreclosing trust deed Advancements for each provision of the trust deed in regards to insurance or taxes. As for a non-monetary default, reasons for foreclosure could include an acceleration clause default because the borrower transferred the encumbering or title property in violation of the provisions outlined in the deed of trust. Another reason is the borrower

60 destroyed the property value by removing or demolishing the building(s), or by failing to keep the property in top condition. Necessary documents for foreclosure There are documents that you will require in order to begin the foreclosure process and include the following: Declaration of Default (DOD) Notice of Breach (NOB) and the election to sell under the deed of trust. Subsection of Trustee (SOT) (required if there is any officer other than the initial named trustee) or Non-military affidavit (required if an individual) Under the beneficiary s instructions, the foreclosure officer will prepare the above documents. Once prepared, the officer will have all beneficiaries involved sign the DOD, NOB, SOT and the Non-military Affidavit with the attached notarization. Note: Property can also be foreclosed by a senior lienor or through a deed in lieu. Trustee Sale

61 In a non-judicial foreclosure, the trustee has the power to advertise and sell the property to a bidder. The successful purchaser receives a signed trustee s deed, which is recorded at the county recorder s office by the trustee under the trust deed. After the sale, there is no equitable right of redemption to the trustee or any other possible junior lien-holder. When all is said and done, the entire foreclosure process takes approximately 110 days to complete (usually 90 days for the redemption term and 12 more for the advertising). It is usually common for foreclosure to start, but does not carry all the way into sale. The reason is because when an investor takes the foreclosure action, the borrower often realizes the seriousness of the matter and will make the effort to make the agreed payments on time. Bankruptcy Sometimes, in order to avoid the selling of their property through foreclosure, a borrower will try to obtain protection from what is known as an automatic stay. In short, the borrower will file a petition for bankruptcy. A bankruptcy petition that is filed in a federal bankruptcy court before the foreclosure sale of property stops the trustee, in a foreclosure process, from selling the property until the automatic stay is lifted. At this time, a Temporary Restraining Order will be set in place and will delay the trustee s sale until the state court can determine whether or

62 not a preliminary injunction will be granted, until a trial or a full hearing can take place regarding the matter. When it comes to bankruptcy, the investor will require the assistance of an attorney to appear in court, in order to request that relief be granted from the automatic stay. An attorney will also be required to respond to the Temporary Restraining Order. Should a borrower file for bankruptcy, it is always in your best interest to respond as quickly as possible to ensure that you receive full payment of the amount owed to you. This includes all legal costs, fees and expenses that you had to endure while processing the foreclosure, as well as those costs linked to having to take action in responding to the bankruptcy petition.

63 Chapter 13 Pitfalls for Investors to Watch For Although a trust deed investment is one of the safer investments you can make, it is imperative that you understand there are still risks involved. The best way to ensure that you avoid pitfalls is to learn as much as you can about trust deed investing and everything it involves. However, to give you an idea of some of the pitfalls you should watch out for, the following are a few tips: It is always in your best interest to physically inspect any real estate you are intending to invest in, even if the property has already been checked out by the appraiser, broker or title company. Take the time to establish your personal opinion regarding the value of the real estate collateral. You can do this by using a number of approaches such as: Ask your realtor for information on closed sales of comparable properties If you were to purchase the property today, what would it be worth to you? Read the appraisal Take the time to learn the difference between personal and real property. You don t want to confuse personal property for real property when you are

64 establishing your opinion in regards to value. Real property is that which is considered to be affixed to the earth. However, don t mistake all property that is fastened to the ground to be real property; some of these items are personal. You should make it a point to know how the borrower is planning to pay the private money loan. Just because short term loans are primarily funded based on real estate equity, you should discover what the borrower has already pre-approved for their take out loan. When it comes to Loan to Value Ratio that concerns homes occupied by owners, you should never lend out a LTV that exceeds 60%, even if the home appears to be the most ideal of owner occupied homes. Likewise, as far as non-owner occupied homes are concerned, the LTV should not exceed 50% You should never rely on future promises regarding improvements unless the proper draws for the upcoming work that is to be completed is officially set up. Make sure you do not want or require any final, additional documentation before you close. Such documentation can include, but is not limited to following: Certificate of occupancy Well report Proof of purchase cost Notice of completion

65 Closing statements Roof reports Toxic reports Sign off of final permit card Etc. Take the time to research everything you can about trust deed investments. Speak to qualified professionals, and don t be afraid to ask questions, or rethink your decisions before making an investment. By following these guidelines, you will lower the risk you take when making a trust deed investment, and will be less likely to experience a pitfall.

66 Chapter 14 Frequently Asked Questions Since you are new to mortgage investing, you may have questions in regards to what it is, what it can do for you, and if mortgage investing is really worth it in the long run. While all of your questions may not be answered, the following is a short list of the most frequently asked questions that pertain to mortgage investing, and should provide you with a good idea of what you can expect. What is the Mortgage Investment Yield? The standard yield is 11 14% per annum. However, it is not uncommon for some mortgages to have higher yields. How long is a Mortgage Investment Term? You have complete control over the term of the loan. While some loans can have a 15 year term, many have a three year term or less. Ultimately, the choice is yours. Is a Mortgage Investment Safe?

67 Yes! In fact, of all the investments you can make, mortgage loans are rated as one of the safest. For this reason, home interest rates are far lower in comparison to credit card rates. Private money loans are generally based on the real estate value itself, to the degree of the individual borrower s credit. Is a Mortgage Investment Liquid? A mortgage investment is not as liquid as a stock or bond. That being said, it is recommended that you only invest money you will not need returned to you quickly. How much money is required to make a Mortgage Investment? To give you a general idea, most mortgages range from $10,000 - $50,000. However, you are in complete control over your investment, because you are the only one who owns your mortgage. The closing should occur at your attorney s office, or at a Title Company. Make sure you obtain title insurance and an independent property appraisal, as well as other significant documents that are required. Your check should be given directly to your attorney or the Title Company. Is a Mortgage Investment more Trouble than it s Worth? No. With a mortgage investment you have control over when you receive your checks, which allows you to obtain your money as quickly as possible. Furthermore, if it is your

68 wish to not be in direct contact with the borrower, simply set up your mortgage investment plan with a third party, such as a collection firm or your bank, and they will collect the payments and contact the borrower on your behalf. What about IRA s and other Retirement Programs? A mortgage investment is a great investment for your Pension Plan or self-directed IRA (Individual Retirement Account). The reason is because if you use your Pension Plan or IRA, your income is tax deferred and can increase faster, as you will not have to pay taxes so you will have more money for gaining interest. Are their Precautions I should take? First and foremost, you need to familiarize yourself with the meaning of Loan to Value (LTV). Remember, all things being equal, the greater the Loan to Value, the more risky the loan. LTV is the percentage of the loan to the property value. Therefore, a $70,000 loan to a property worth $100,000 has a 70% LTV. Most lenders are in agreement that on certain types of loans, you would require a lower Loan to Value. Loans that involve the least amount of risk are those to Homeowners living in their own home Second homes Rental properties

69 Commercial properties Vacant Land While most lenders will only lend 50% or less of the actual value of vacant land, it is also true that many lenders will not lend to corporations or trusts. Thus, it is highly recommended that if you do decide to lend to either of the above mentioned entities, you require a larger money down payment and/or a lower Loan to Value. In addition, it is highly recommended that you always insist the Borrower takes personal responsibility on the promissory note.

70 Conclusion By now you should have a good understanding of what is involved when it comes to trust deed investing, and should feel confident that with the knowledge you have in your possession, you can properly assess the risks involved. In addition, you should also have a good idea of what to expect from your mortgage broker, and should be able to make educated decisions in regards to the loans you wish to invest in. Don t forget, the more you learn about trust deed investments, the safer the risk and the higher the potential for excellent return. Thus, make the effort to keep these seven trust deed investing tips in mind when you are making an investment: 1. Know the market value and equity of the real property, as well as your loan security. 2. Know your borrower s financial status and their credit worthiness. 3. Understand the escrow process. 4. Find out the experience, knowledge and integrity of the broker with whom the transaction will be arranged or made.

71 5. Keep all documents and important papers that describe, and provide evidence and security for the loan, in a safe and accessible place. 6. Know how to recover your investment when the borrower does not meet payment. 7. Understand loan servicing authority, provisions and compensation. Always remember, although trust deed investments are one of the safer investment risks you can take, and have the potential to provide you with high return, ultimately the risk is yours. That being the case, you may find it in your best interest to first speak with a qualified professional or a mortgage loan broker before you make any commitments with your money.