Many transactions get derailed because the documents required come late in the transaction, or the borrower provides the wrong or insufficient documentation from their current lender. The following is a description of Payoffs and Reinstatement documents, why they are important to you as an investor, and how to avoid pitfalls that can derail your investment transaction and cost you unnecessary time and expense.
A payoff statement reflects the complete amount to payoff the debt. It sounds simple enough, but investors and borrowers frequently confuse the balance on the borrower’s last statement with a payoff. They are not the same and the dinstiction is especially important for hard money loans. Frequently, the difference between a payoff statement and the amount reflected on the borrower’s last statement are startlingly different; especially for senior liens that are delinquent.
Payoff statements come from the lender and is a detailed statement with the accounting of the amount the lender is owed to satisfy the debt. This may include items such as delinquent tax and insurance escrow impounds, legal fees, title fees to create and record documents to release the lien, and any other advances that the lender may have made prior to the payoff requests. These items may or may not be reflected on a recent statement the borrower received, depending on when the expense or advance occurred. For example, the borrower could have been in forbearance negotiations with the lender prior to transacting business with you and your lender which could have resulted in thousands of dollars in accrued legal fees due as part of the debt.
A payoff make take longer to receive than you expect, so insist on seeing a payoff statement early in your due diligence before you put a lot of time, energy and expense in evaluating the property or generating loan documents. In many states lenders have as much as three weeks to produce a payoff statement. You may be thinking, "What could take so long to produce a payoff statement? Shouldn’t the lender already know what is owed to them?“ If the loan is performing, a payoff should be relatively simple to generate quickly. But if the loan is delinquent the lender has likely outsourced a number of functions to vendors for which they have not yet received invoices. For example, the lender may have re-valued the property and hired an appraiser, or consulted an attorney on a foreclosure, or incurred trustee fees, etc. In order to produce a payoff, the lender has to query all the vendors and make sure they include the amounts due to those vendors to the payoff.
In traditional loan transactions, the escrow and/or title company requests the payoff from the lender. Savvy investors know that waiting for the payoff to be provided by escrow or title means the payoff statement will likely appear near the end of the transaction. If the payoff amount is considerably more than expected, and it is received at the end of the transaction, it may derail the transaction, and leave the investor and private money lender on the hook for up front due diligence expenses such as appraisals and legal work. You can avoid some transaction risk by working with your private money lender and borrower to get the payoff up front as a condition for moving to the next due diligence step. The borrower can request the payoff statement or, the investor and/or private money lender can request the payoff statement as long as the borrower signs a document authorizing them to do so on their behalf.
The payoff statement will impact your loan to value criteria. Knowing the actual payoff early on may weed out transactions that do not meet your lending standards. Let’s say you only invested in loans up to a maximum of 60% loan to value. The loan transaction under evaluation is a loan on a 7 unit apartment building worth $300,000. The borrower thought, based on their last payoff, that they owed $175,000 on their existing loan. So far so good. $175,000 / $300,000 = 58% LTV. As you learn more about the transaction, it turns out the borrower didn’t pay their property taxes, and the lender advanced those funds on the borrower’s behalf. The borrower also engaged the lender to draft a loan modification and hired outside counsel to do so. The payoff statement is received and the outstanding balance is $190,000 because of the additional advances, and not the $175,000 the borrower thought. If the borrower could not separately pay the advances back to the lender, you would have to make a loan of $190,000 / $300,000 = 63% loan to value. And this is not even the final LTV because it doesn’t include title, escrow and other transaction costs to originate the loan. You may or may not proceed with the loan. The point is that not having an actual payoff could throw off your initial evaluation of the loan. What if, before you had the actual payoff, you spent $750 for an appraisal and $2,500 for a phase I environmental study? You may be less willing to back out of the transaction if the loan failed your loan to value standard because of the time and funds invested in the due diligence.
Payoffs for government liens such as IRS lien, state tax liens, child support liens, etc. may take many weeks or months to obtain. If one of these liens appears on a borrower’s application or on the preliminary title report, be judicious in time and expenses in evaluating the loan until the payoff is obtained. Government lien payoffs rarely come in at the value stated on the recorded face of the document and frequently lead to unpleasant surprises.
A reinstatement statement is used for delinquent loans and gives a detailed accounting of the amount necessary to reinstate the loan to a current performing status.
This statement is required if you are originating a new junior loan which, by definition, leaves the borrower’s existing loan in place. As part of your loan transaction, escrow /title will be instructed to bring the senior loan completely current if it is delinquent.
It is a mistake to believe that you can determine the amount to bring the senior loan current by simply looking at the payoff statement. The payoff statement usually does not contain enough detail to make the precise determination as to the amount to send to reinstate the loan.