Servicing Loans — Not for the Faint of Heart

Okay, so you sold your property and allowed the buyer to pay you some of the purchase price over time: you are now in the business of loan servicing, a business so full of rules that many banks have opted out. Some of the rules are easy to comply with; others border on the impossible.

The most onerous requirements revolve around servicing loans secured by owner-occupied, single-family homes with one to four units (SFH 1-4), including freestanding homes, duplexes, triplexes, and four-plexes. These rules have changed dramatically in the past 18 months, and are now so complex that I won’t deal with them in this column. Instead, I’ll talk about servicing other real estate-backed loans (also called notes).

First things first: make sure your borrower understands the payment schedule and dates, who to pay, as well as how and where to send the money. Also, be sure you and your borrower exchange contact information so you can get in touch, should the need arise, because the need will arise. If the borrower pays you in cash or with a money order, be sure to provide a receipt.

Next, you need to make a provision for how payments are applied, including interest, principal, late fees (if any) and repayments on any advances you may have made for property taxes, insurance, or payments on other loans. Loan documents need to allow for those advances, and they need to include permission to charge interest on those advances. Typically, the interest rate on advances will be the same as the interest rate on the note. Principal is the money originally loaned. Interest is the rent on the money (the monthly cost of the loan).

Once you’ve received a payment, what do you do with it (other than deposit it)? Now you must account for it. This involves recording how the money was applied to the loan: how much went toward principal, interest, advances, fees, etc. Be sure that your breakdown exactly matches how much you received.

When it comes to loan documents, you may want to provide an amortization schedule to your buyer—a breakdown of monthly principal and interest. As long as the borrower adheres to the original schedule, you don’t have to calculate the breakdown each month. If you need an amortization schedule, your Realtor can provide one.

If your borrower pays more than the amortization schedule requires, and the money is not applied to advances or fees, then you’ll need to recalculate the amortization schedule because a bigger portion of future payments will now go toward the principal.

If your borrower sends more than one payment at a time, the additional payments can be credited toward future payments without changing the amortization schedule—in essence, your borrower will be able to skip a payment. If you do get paid more than the expected amount, it is important to be explicit with your borrower that the money was applied to next month’s payment. If the borrower prefers to have the additional funds go toward reducing the principal, then you’ll need a new amortization schedule. The additional money can either go to a future payment or to reduce the principal, but not both.

At the end of the year, you’ll need to provide a clear accounting of how all loan payments were applied. Be sure to get the borrower’s social security number so you can complete the 1098 tax form. The borrower should send you a 1099 form. If the two don’t match, you’ll both receive a love note from the Internal Revenue Service.

The Dodd Frank legislation and the California Homeowner’s Bill of Rights should give any sane person pause before taking on loan servicing. But hey, if you want a challenge…

If you have questions about real estate or property management, please contact me at rselzer@selzerrealty.com or visit www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you’re a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.