If you are interested in becoming a private lender, then it will be important to know what kinds of documentation you’ll need to use when funding a deal. In most cases, there will be at least three separate agreements that will have to be signed.
While discussing paperwork is not usually interesting, this is one of the crucial parts of mortgage lending. Done correctly, it can protect the lender from a lot of unwanted risk. Conversely, a sloppy understanding and execution can cause a serious hazard of loss. In this article, I will outline four of the most common components of a mortgage loan.
The Promissory Note
A promissory note is a legal document that evidences a debt. It is typically only signed by the borrower (unlike a loan agreement, which involves both parties). It explains the terms and conditions of the loan and outlines any of the following:
- the principal amount (the balance of the loan).
- the maturity date (when it must be repaid).
- the interest rate.
- origination or administrative fees.
- late payment penalties.
- the payment schedule (how often interest and/or principal payments must be made and on what day of the month).
- the minimum payment amount.
- whether there are any penalties for repaying the debt ahead of the maturity date.
- whether there is collateral, such as a mortgage.
- what might cause a default on the loan agreement, beyond missing payments. For example, many lenders consider a substantive change in the borrower’s credit or an application for bankruptcy to be a default. As such, they may immediately recall the loan in those events.
The Mortgage Agreement
The mortgage agreement is what collateralizes the promissory note with real estate. It usually highlights important terms of the loan agreement, along with:
- the legal description of the real estate (which will usually differ from the civic address).
- requiring the borrower to maintain adequate insurance on the property.
- underscoring that any renovations that are done to the property are also included as collateral.
- specifying inappropriate use of the lands in question, which might cause them to devalue.
- noting that the lender has the right to seize the real estate in the event that the loan cannot be repaid.
- Assigning any rent or other revenues earned from the property in favor of the lender as further security.
The Certificate of Independent Legal Advice
A Certificate of Independent Legal Advice is sometimes called an ILA. It is a document signed by both the borrower and her attorney that usually states the following:
- The borrower understands the terms of the loan and mortgage agreement
- The borrower is aware of the risks involved
- The borrower is not being pressured into taking a loan
- The lawyer has provided legal advice to the borrower and without consideration for any other party
- The lawyer believes that the borrower understands what she is signing
The ILA is for the protection of the lender. It helps to insulate it from any claims of being tricked or coerced into taking a loan.
The Affidavit of Execution
An Affidavit of Execution is a document that is signed by a witness, typically an attorney or a notary public. It says that that the person witnessed the borrower sign the aforementioned legal agreements.
Conclusion: Why This Matters
Inexperienced lenders sometimes believe that they can secure a loan with real estate by simply including it in the contract. However, the laws generally require specific documents to be executed in order for a mortgage to be registered. Further, those legal agreements may need be filed with the relevant government agencies. In some cases, this can only be done by an attorney or notary public.
Author bio: Alexis Assadi is an entrepreneur and independent investor. His portfolio is heavily concentrated on various mortgage loans, including syndications, first, second and third liens. He enjoys writing about business and real estate financing, and helping others improve their due diligence skills. Follow Alexis on Twitter.