Lending comes with inherent risk. There is always a chance that something will go wrong at some point along the way. However, a way must be found to provide borrowers with funding despite those risks while still protecting investors from the worst-possible fallout.
That’s where a risk mitigation plan comes into play. At Pacific Private Money Inc., we follow a simple six-step risk mitigation plan that helps ensure investors are protected and see the return they deserve, and that borrowers can access the funds they need to purchase the home of their dreams. While our risk mitigation plan might include only six steps, each is carefully thought out and strategically included.
The goal is to provide robust protection while also enabling agility and speed. It’s part of what makes us such an innovative private lender. Of course, it helps to understand each of the steps in that plan. Below, we’ll explore them in greater depth to help you understand what to look for and why.
Assessing the Value
The first step in our risk mitigation plan is to ascertain that the property in question has enough value to support the loan. However, that’s not as simple as it might sound. Yes, a professional property appraisal is part of the process, but many factors play a role in determining value. Let’s break those down a bit.
First, there’s the cost of the land and home. Is the property worth what’s being asked? Is the condition of the home enough to support the asked for price? Is the land as valuable as the asking price? If not, what is an appropriate value? Are there any issues or concerns that might detract from home or land value, such as damage to or repairs needed in the home?
The location of the property will also play a role. Where is it situated in relation to major population centers? What about the ocean or popular tourist destinations?
Next up, we have to consider the expected appreciation of the land. What are the current trends in the area in terms of appreciation and speed? What future trends might affect appreciation, such as gentrification in urban areas, or further development in more urban areas?
Of course, each case is unique. A home close to San Francisco Bay will be very different from one in Oakland, or a high-end property close to Big Sur. At Pacific Private Money Inc., we understand that each borrower’s needs are unique, but also take our commitment to protecting our investors very seriously. Our risk mitigation plan is the solution to meeting both of those needs.
Checking for a Clear Title
The second of the six steps in our risk mitigation plan is ensuring that the property has a clear title. That sounds simple, and the concept is, but ensuring that’s the case can require a great deal of legwork and research. Technically, a clear title is one where there is no lien or levy from creditors or other parties that could pose a threat to legal ownership.
The reason a clear title is necessary is that it firmly establishes who owns the property. Without a clear title, the property cannot be sold, which would throw a wrench in the works when it comes to private mortgage lending. Several different factors can complicate the situation, including the following:
- Heirs having some claim on the property
- The presence of a quitclaim deed
- Fraud in the form of a false deed
- The property was inherited and the heir then got married
- Missing transactions in county records
- The presence of a lis pendens
- Joint ownership of a home by a separated but not divorced couple
- Ownership transferred to a trust or other body
We thoroughly research the property’s title to ensure there are no encumbrances and that the sale can proceed smoothly. That protects our investors, but also helps ensure that homeowners are safeguarded, as well. What happens if there are encumbrances on the title? It’s time to take action.
Clearing the title will depend on the actual encumbrance in question. For instance, if a deed was not recorded, the property owner will need to contact the county clerk’s office and follow the required steps to record the deed. If a married couple who owned the property jointly were to separate, but not divorce, both parties would need to sign off on the sale for it to legally transfer to a new owner even if the spouse living in the home has no idea where the other spouse is currently.
Many of these problems are very complex and can wreak havoc on a real estate transaction. We go to great lengths to ensure that all titles are free and clear. If there is no clear title, we will not lend on the property.
Verify Income/Ability to Repay
Step three in our risk mitigation plan is to ensure that the borrower can repay the mortgage. This generally involves having them provide proof of income, as well as proof of their financial responsibilities that might claim a portion of that income. The goal is to ensure that the borrower has ample income each month to make the mortgage payment.
However, we do not necessarily hinge a lending decision on “employment”. We’ve worked with many clients who are not employed in a traditional sense, including business owners, serial entrepreneurs, and even professionals between employers. We seek to verify that borrowers have income sufficient to meet their financial obligations, including the new mortgage payment, regardless of where that income might come from.
Some forms of acceptable income that we will include in our evaluation include the following:
- Investment income
- Trust payments
- Spousal support
- Self-employed income
- Nontaxable income
- Retirement income
Of course, it’s not just about verifying income. It’s also about investigating cash outflow. What bills does the borrower have? What other responsibilities do they have? What other claims exist on their income?
Every bill that the borrower must pay eats away a little more of their financial stability. Our goal is to ensure that borrowers are well-positioned to remain financially viable. That means more than just meeting financial obligations, though. Borrowers also need money for discretionary spending – food for their children, and gas for their cars, for instance.
Also, we check more than just income. We understand that a borrower’s ability to repay might also be based on the sale of existing assets, so we look at assets as well as debt levels and conventional sources of income.
This step is more about balance than it is checking the numbers. Yes, sufficient income is very important. However, the outflow is just as critical, as is the quality of life. We strive to ensure that our borrowers are not overtaxed with all their financial obligations to the point that their quality of life decreases. It’s part of our role as a responsible lender.
Ensuring Good Hazard Insurance Is Purchased
With the fourth step, our risk mitigation plan ensures that there is good hazard insurance in place. This coverage is necessary to protect against property damage that might reduce the value of the property. Hazard insurance isn’t a standalone policy, though. It’s included with the homeowner’s insurance that borrowers are required to have in place before we finalize the mortgage.
Hazard insurance applies to the physical structure of the home and does not cover any of the home’s contents. However, it’s important to understand that policies vary dramatically from insurer to insurer, so borrowers must choose from the best homeowner’s insurance companies to get the right amount of coverage and avoid companies that do anything in their power to avoid paying out on a claim.
Some of the more commonly covered hazards include the following:
- Wind damage
- Vehicle damage on the property
However, other policies may cover other hazards. Some of these “optional” threats include:
- Riots/civil unrest
- Falling objects
- Smoke damage
- Damage caused by aircraft
- Ice and snow accumulation damage
- Electrical damage
- Water damage due to home appliances or systems
Why is hazard insurance necessary? Simply put, the mortgage is made against the value of the home. Anything that damages the home detracts from the property’s value.
Does it matter, though? Isn’t hazard insurance essentially throwing money away? How likely is it that a home is going to sustain damage from a falling aircraft, for instance?
While some hazards are less likely than others, some are very real threats. Damage from these “perils” constitutes the most frequent insurance claims, and generally cost the most money. Fire and lightning damage is by far the most common and most costly – this is particularly true in many areas of California where the threat of wildfires remains ever-present. Wind and hail damage are also very common (and costly) claims.
Does that mean fire/lightning and wind/hail damage coverage are the only two coverage types borrowers should consider? Not at all. We believe in tailoring hazard coverage to the threats most common to specific geographic areas. However, we also understand that most listed hazards are relatively common across the board. Broader coverage is always preferable to narrow coverage to protect the value of the property.
First Mortgage Review
In some cases, we will consider a loan in the second position. However, before we will commit to that, we thoroughly review the first mortgage. This part of our risk mitigation plan is designed to ensure that our investors are protected, but also to help make sure that borrowers are not getting in over their head, financially speaking.
Second mortgages are inherently riskier than first mortgages. The reason for this is simple – if the borrower were to default, then the first mortgage holder (senior debt) would be paid first. The second mortgage holder (junior debt) would be paid only after all senior debt was satisfied. So, there is a greater chance of a lender not being paid completely in this case.
To mitigate this risk as much as possible while still providing borrowers with access to the funds they need, we review the first mortgage in great depth. Some of the factors we consider during our review include the following:
- Remaining Balance – The amount remaining unpaid on the mortgage is a considerable factor in our decision to lend or not to lend. This bears directly on the risk we (and our investors) take on by offering a loan. Generally, lower remaining balances are preferable, but we can work with borrowers in situations with high remaining balances in certain situations.
- LTV – The loan to value ratio of the new loan compared to the property value and the remaining balance on the first mortgage is another important consideration. In some instances, a property may have appreciated significantly, even if there is a considerable remaining balance on the first mortgage. This provides leeway for us and reduces the risk of a second mortgage.
- Equity – Equity is the difference between the value of the property and the balance of the first mortgage. We understand that it is possible for borrowers to have considerable equity built up in a home even with a large remaining balance on the first mortgage and we’re willing to consider a second mortgage in some situations.
Again, while we are happy to offer lending solutions for second position mortgages in some situations, we cannot lend in all such situations. Each case is unique and we make a decision based on borrower specifics and in-depth research for each potential loan. The goal is to balance risk and create a viable solution for all parties involved, including our investors and the borrowers who depend on us.
The final step in our risk mitigation plan is to verify the borrower’s credit. We follow standard procedures here, intending to reduce risk through due diligence. This goes much deeper than simply checking a borrower’s FICO® score, although that does play a role, as well.
We research a borrower’s credit in several key areas (all of which feed into their FICO score). These include:
- Payment History – We look at things like missed payments and late payments. We also consider current black marks on their credit, such as foreclosures, repossessions, and bankruptcies. Negative items on a credit report do not necessarily preclude a borrower from obtaining a loan they need, but this information does temper our decision.
- Amount Owed – The amount a borrower owes to other creditors is an important metric of their financial stability. It also speaks to their spending habits and creditworthiness over time.
- Length of History – We expect our borrowers to have a modicum of credit history going back several years. New credit does not necessarily prevent a borrower from obtaining a loan, but this is a factor in our decision.
- Credit Types – We like to see a broad range of credit types in a prospective borrower’s history. This includes credit cards, auto loans, and other types of credit. An unbalanced credit history does not preclude a borrower from obtaining a mortgage with us, but we do consider that in our ultimate decision.
- New Credit – There is nothing wrong with a consumer applying for new credit. It’s their right under the law. However, multiple applications with lenders or credit card issuers within a short period can be seen as a red flag that a borrower is experiencing financial difficulties. Again, this doesn’t necessarily prevent a borrower from obtaining a loan with us, but it will factor into our lending decision.
Ultimately, a borrower’s credit history and score are less important in our lending decision than other factors. For instance, a borrower with a less than perfect credit score, but with an ample down payment and substantial income might be approved for a mortgage, where a borrower with perfect credit but limited or no verifiable income might be denied. We strive to take a balanced approach to loan approval based on the unique factors of each situation.
A Plan for Growth and Success
At Pacific Private Money Inc., we strive to mitigate risk to our lenders while offering our borrowers access to the funding they need to purchase their dream home. We serve clients throughout California but take each application on a case-by-case basis. We realize there’s no such thing as a one-size-fits-all approach when it comes to mortgages, and that everyone deserves the opportunity to own their own home.
Our unique approach allows us to be agile in one of the most competitive markets in the world. It also enables us to serve clients who would be left out with conventional lenders through no fault of their own. From owner-occupied loans to construction, commercial, and non-owner occupied acquisition and rehab loans, we offer flexible financing for those in need. Contact us today to learn more about our loan options or to become an investor.