By: Sheena Johnson
Property-backed loan closings and real estate closings can look very different. However, both closings have something in common: most require comprehensive due diligence on the collateral property. The quality and extent of due diligence impacts the title insurance coverage issued at closing. Without the right title insurance coverage, a lender may not be able to fund a closing. Borrowers and buyers should prepare to perform comprehensive due diligence in advance of a loan closing.
Should Borrowers or Buyers Conduct Due Diligence?
Nearly every lender expects to receive a comprehensive, cover-all lender’s title insurance policy. When a borrower or buyer is using property as collateral, the protections offered in the title insurance policies must be backed by the reports, assessments, and other documents produced from doing due diligence on the property. The quality of due diligence conducted has a direct impact on the loan closing timeline.
Thus, before deciding to limit or waive due diligence, buyers and borrowers should ask themselves the following questions:
- Do I need a loan to close on the property?
- Do I plan to refinance my current loan that is secured by the property?
- Is it possible that I will need to use the property as collateral for a future loan?
If the answers to any of the above questions are yes, the buyer or borrower must conduct quality due diligence to help speed up the loan closing.
Due Diligence: What is Required?
Due diligence exists in large part for the lender’s benefit. Before issuing a loan for a large sum of money, a lender has to be confident that the property serving as collateral is (1) properly appraised, (2) free and clear of liens, encumbrances, and title defects, (3) non-hazardous, and (4) zoned correctly, among many other factors.
Due diligence impacts a lender’s decision whether to lend or not, how much to lend, and under what terms. Many lenders will require, at the very least:
- An appraisal, which assesses the underlying value of the property and helps the lender determine how much to lend
- An updated title exam, which identifies conveyance issues or the property’s risks related to mortgage liens, legal judgments, or unpaid property taxes
- An updated survey, which identifies the boundaries of the property and illustrates any easements or right-of-ways
Some lenders may also require environmental assessments (Phases I and II) to identify environmental risks associated with the property. Additional information, assessments, and valuations may be required, including zoning reports, boundary reports, tenant estoppel certificates, or rent rolls.
Lenders require so much assurance because post-closing issues are expensive to fix and may put the loan and collateral in jeopardy. A comprehensive title insurance policy, backed by thorough due diligence, protects a lender from many issues that could drain their resources.
Timing and Conducting the Necessary Due Diligence
The total time to conduct due diligence on a property can range from fourteen days to a few months. A title exam can take one or two weeks to complete, while a survey or Phase I/II report can each take two to four weeks.
Buyers and borrowers are often tempted to cut corners on due diligence for the sake of a quick closing. However, thorough due diligence work will actually expedite loan closings. If lenders do not have the due diligence information they need, they cannot receive a comprehensive title insurance policy. To avoid denying these loans, lenders must then order the evaluations, assessments, and exams that provide the necessary data. Performing due diligence after the fact like this can cause significant delays.
Luckily, given the consistent nature of due diligence in loan closings, a buyer or borrower can easily prepare the right due diligence work in advance:
- Either obtain the information an appraiser may need or appoint a person that can provide the necessary information to the appraiser
- Order an updated title exam and an updated survey
Be prepared to request assessments as required by the lender
Due diligence is not only recommended, it is necessary if a buyer or borrower uses real property as collateral for a loan. While it may seem costly and time-consuming, failure to conduct thorough due diligence on the collateral property can result in post-closing discoveries that are far more problematic. High-quality due diligence is well worth the investment and will expedite your loan closing. To protect your interests during any step of the loan closing process, reach out to an experienced Chugh, LLP attorney.