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Why Market Value is Critical in
Your Investment Decision
The market value of the property should be made available to you before you commit your
trust deed
investment funds.
The
market value of the property is critical to your decision to lend
your funds or purchase a trust deed because there is the
possibility that the only way to recover your investment is through
the sale of the property.
The market value is
generally presented in the form of an appraisal report which
considers
comparable sales and other relevant data by a competent
professional. The appraised value is the appraiser's final estimate
of market value.
Fair market value is often defined as the
price that the property would sell for on the open market, agreed on
between a willing buyer and a willing seller, with neither being
required to act, and both having reasonable knowledge of the
relevant facts.
However,
this is not the realistic perspective needed for trust deed
investing.
What is important to a trust deed investor is the
sales price that can be realized in a fast sale with a "willing
buyer" and a "willing seller."
You should review the appraisal with the
appraiser, mortgage loan broker, title insurance broker, and local
realtors with this in mind to understand the trends that could affect market value
during the term of the loan.
Although you or your mortgage loan broker
customarily
retains the appraisal services, the borrower typically pays for the
cost of the appraisal report.
The property is the security for your
investment, so you should make an effort to inspect it, even though
your mortgage loan broker, real estate broker, or appraiser may also have inspected the
property.
Loan-to-Value
The loan-to-value ratio is the total loans
against the property, including your loan, divided by the market
value of the property. For
example, if a borrower has a first deed of trust in the amount of
$25,000.00 and is requesting a second deed of trust in the amount of
$40,000.00 and no other liens will be placed against the property,
which is valued at $100,000.00, the loan-to-value ratio is 65%
($25,000.00 + $40,000.00 divided by $100,000.00 = 65%).
The lower the loan-to-value ratio and the greater
the borrower’s equity, the more incentive for the borrower to
protect the equity in the property (i.e., sell or refinance the
property if unable to make payments under your promissory note) or
for a third-party bidder to purchase the property at a foreclosure
sale.
If the total
loans or other liens exceed a reasonable loan-to-value ratio or
exceed the market value, the property will provide little or no
security for your investment. A sufficient equity should be
maintained in the property to allow for the fees, costs, and
expenses that you will incur in foreclosing if that becomes
necessary.
It is important to note that the borrower’s equity is not the
same as the protective equity. The borrower’s equity is the
difference between the market value of the property and the total
indebtedness secured by the property. The protective equity is the
difference between the market value of the property and the total
indebtedness of loans senior to your loan and your loan, but does
not include loans junior to your loan.
The existence of a lien junior to your loan will
diminish the borrower’s equity, increase the borrower’s payments or
debt service, and reduce the borrower’s ability to refinance. In the
event of a default regarding senior loans (liens), beneficiaries who
have a right of lien upon a property of another (lienors) and who
are junior are entitled to protect their security interest in the
property by paying the borrower’s delinquencies on senior liens
and/or by commencing their own foreclosure action. Therefore, junior
lien holders should keep informed of defaults in connection with senior
loans (liens).
Preliminary Report
The mortgage loan broker is required to provide
you with the option to apply to purchase title insurance or an
endorsement to an existing policy. The
Preliminary Title Report (Prelim), is prepared by a title company and is an
offer to insure and does not provide conclusive information about
the status of title.
Title insurance companies offer different types
of coverage. You should ask your mortgage loan broker or the title company for an explanation of the different types of
coverage available (e.g., CLTA and ALTA) and to what extent you are
insured.
You should not consider a Prelim as providing you
with reasonably current information unless it is dated within 90
days of your examination of the report. Therefore, you should ask
your mortgage loan broker to provide an amended and current Prelim dated as closely as
possible to your commitment to fund a loan or purchase a promissory
note.
The current Prelim should provide the following
information regarding the property:
-
the name(s) of the owner (s);
-
legal description, street
address (if available), and the assessor’s parcel number;
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assessor’s plat map, which
illustrates the configuration, dimensions, and general location of
the property;
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assessed valuation;
-
existence and priority of liens
and encumbrances;
-
the name of the owner (s) of
existing lien (s); i.e., the owner of record of any deed of trust
(lien) which you may be purchasing;
-
requests for notices concerning
status of the liens, notices of default (NOD), and notices of
trustee’s sale (NOS);
-
notice of a lawsuit or
bankruptcy affecting the property; and
-
a potential off-record interest of
a spouse or other party.
In reviewing the current Prelim for the above
information, be alert to various problems which might affect the
market value and equity of the property and the security for your
loan. If any issues are encountered, ask your mortgage loan broker or
a title officer for a full explanation.
Call 1-213-437-6379 toll free now for more
information.
Trust Deed Real Estate Investing
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