Due Diligence Non-Negotiables
Buying defective paper is highly profitable, but it carries unique risks. Before wiring funds for any S&D note, three non-negotiable checks must be cleared.
The Golden Rule: You are buying the debt, but the real estate is your safety net. If the borrower stops paying, you must be able to foreclose, sell the property, and still make a profit.
1. Maximum 70% LTV
Never buy a defective note where the borrower owes more than 70% of the property’s current market value. This 30% equity cushion protects you against market downturns, foreclosure legal fees, and property preservation costs. If the property is worth $300,000, the maximum UPB you should acquire is $210,000.
2. Collateral is King: The BPO
Never trust the original appraisal in the loan file — it may be outdated or inflated. Order an independent Broker Price Opinion (BPO). A local real estate agent physically drives by the property, assesses its condition, pulls recent comps, and provides a current valuation. Your entire risk model is based on this number.
3. Title Integrity: The O&E Report
A defective loan document is fine; a defective title is fatal. Run an O&E (Ownership and Encumbrance) report to ensure your note is truly in the first lien position. The O&E report reveals hidden IRS tax liens, unrecorded second mortgages, mechanic’s liens, and breaks in the chain of title.