Although lender requirements vary, a borrower must be prepared to provide certain information and documents when applying for financing to purchase commercial or residential real property. A mortgage lender’s due diligence before closing focuses on the value of the real estate and a borrower’s ability to repay the loan. While the process for residential real estate lending is not quite as involved as it is for income-producing properties, due diligence in all cases serves to protect the lender’s interests.
Borrower’s Financial Health
The due diligence process in the underwriting of a loan is to minimize the lender’s risk, and it provides verification of the information a borrower gives the lender. A lender will require a borrower’s financial statements and federal tax returns. Generally, for residential real estate transactions, lenders request to see proof of employment, such as recent pay stubs or W-2 forms, to verify income. Additional documentation that lenders request might include federal tax returns for at least the last two years, bank statements for the last three months, and balance sheets if the borrower is self employed. Lenders rate a borrower’s creditworthiness by looking at assets, amount of debt owed, and timely bill payments.
Real Estate Documentation
A lender will require a copy of the purchase contract, which includes a legal description of the property and of the type of deed the seller will convey. The contract should also outline the land, buildings and personal property that are included in the sale, noting any easements or restrictions on the use of the property. Because the real estate serves as collateral to secure the loan, a lender will require title insurance issued by a title company. A lender’s title insurance policy protects the bank or mortgage company against lawsuits or claims relating to ownership. Title examination is a review of public records relating to the ownership history of the property. A title search also identifies any liens, judgments or unpaid property taxes.
Purpose of Appraisal Reports
Property valuation, which is meant to protect the lender, assures that the property meets certain criteria. Primarily, the property must be worth at least as much as the bank or mortgage company is lending the borrower. Consequently, the appraiser’s job is to prepare a report for the lender giving an opinion on the property’s value and not its condition. The lender may also require a professional home inspection before approving the loan, as structural defects can significantly lower the value of the home.
A Look at Insurance Issues
A lender requires a borrower to carry adequate property insurance coverage to protect its interest in the collateral. Mortgages and deeds of trust normally have specific requirements for the insurance a borrower must carry. If a standard policy contains exclusions relating to particular types of losses, a lender generally requires optional coverage in the form of add-on endorsements or policy riders. Depending on the location of the real estate, the borrower may also need to show proof of coverage for special hazards, such as flood and earthquakes, not included in the general policy. The borrower must usually name the lender as an additional insured on all policies.
- Commercial Real Estate Finance Council: Guidelines for Due Diligence on Real Estate in the UK
- Alexander Holburn: Borrowing Checklist
- American Bar Association: Beyond the Loan Process
- Consumer Financial Protection Bureau: What Documents Will My Lender or Mortgage Broker Request After I Have Found the Right Loan for Me?
- American Bar Association: Residential Real Estate FAQs
- Realtor.com: Myths and Facts About Appraisals
- Graves Dougherty Hearon and Moody: A Discussion of Insurance Requirements in Leases and Loan Documents
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