Bulletin: TX2019007

Dear Associates:

Non-Institutional Lender Transactions - Fraud, Due Diligence, and General Requirements

The Company has experienced an increase in requests for various types of coverage involving non-institutional lenders, more commonly referred to as "hard money lenders". Generally speaking, insuring non-institutional loans under a Texas Loan Policy T-2 or T-2R policy is an acceptable risk, except where certain circumstances exist, for example:

1. if the number of beneficiaries exceeds four, 

2. if the policy coverage amount requested exceeds the loan amount,

3. when any portion of the funds are used for construction, remodeling or rehabilitation.

Essentially the hard money lender relies on the perceived value of the property and the coverage provided in the title insurance policy. As a result, hard money lender transactions are significant targets for fraud. Thus, a deeper inquiry into the circumstances surrounding the transaction is necessary. Below are some common fraud factors in non-institutional lender transactions and the due diligence steps that should be followed to avoid fraud claims.

Common Fraud Factors in Non-Institutional Lender Transactions

The following are some common factors the Company's claims department has identified in handling fraud claims in non-institutional loan transactions:

• Documents are frequently signed with loan broker or lender's in-house notaries; 
• Corporate/LLC organizational documents are sloppy, missing information and often poorly drafted; 
• There is no direct contact with the sellers or buyers/borrowers and they are often "unavailable" or "out-of-state";
• There is extreme pressure as a rush transaction requiring an immediate close; 
• Independent escrow handles funds and often sends money outside of the state and country and disburse loan proceeds to parties other than directly to the seller/borrower;
• Payoff demands come from parties other than directly from the private beneficiaries or institutional lenders; and
• The title appears to be free and clear or has minimal liens (check for fraudulent releases). Note that in every instance of a fraud claim involving fraudulent releases, the existing Company Bulletin requirements were not followed.

Due Diligence Steps to Avoid Fraud Claims in Non-Institutional Transactions

• Ensure that loan proceeds are payable to the borrower/seller only, not to a third party unless:
  • being used to pay off existing encumbrances;
  • being paid to contractors/suppliers for work on the property; or  
  • being paid to another escrow or title company in connection with the borrower's purchase of another property (secure evidence that borrower is the actual purchaser); 
• Check that all borrower's signatures match all documentation; 
• Don't accept signatures under a Power of Attorney for any party including seller, borrower or lender without specific underwriter approval; 
• Use your own notary, a notary known to you or a notary from a trusted escrow company. Do not use the borrower's lender's notary or the loan broker's notary; 
• Where seller/borrower is receiving $100,000 or more in loan proceeds, require two forms of identification; and
• If available, run borrowers’ names on Lexis Nexis to help confirm validity. 
• If results from the above due diligence steps raise any concerns with regard to the transaction, then:  
• Contact the seller/borrower directly and ask questions about the real property that only the actual owner would know. For example, how old is the home? Is property vacant? If yes, what is the mailing address on the tax bill? Are you obtaining a loan secured by the property? Do you have existing debts against the property? 
• Confirm that the lender and/or broker performed an actual walkthrough of the property and, if so, who granted access; 
• Check online for photos, etc. that may be available of the seller/borrower or seller/borrower's trustee, member/manager, or officer as the case may be to see if consistent with identification provided; and 
• Review the transaction with your Underwriter.

General Requirements for Non-Institutional Lender Transactions

Underwriter approval is not necessary where all the following exist:

• The policy to be issued is a standard coverage T-2 or T-2R Loan policy. The number of the beneficiaries listed in the Deed of Trust or mortgagees in a Mortgage does not exceed four (4);
• The dollar value of the transaction does not exceed your underwriting authority;
• The Loan to Value does not exceed 80% as determined from the best information available such as the value established by the county assessor or a recently written appraisal from a licensed appraiser;
• The insured amount does not exceed 125% of loan amount (with an appropriate note in the policy or instruction from the insured);
• No portion of the new loan funds will be used for construction, rehabilitation or remodeling; 
• The transaction does not fall within another category requiring underwriting approval; and 
• The due diligence steps above are followed.

Underwriter approval is not necessary if a T-2 or T-2 R Loan policy is being issued where all the following exists:

• The property is single family residence;
• The dollar value of the transaction does not exceed your underwriting authority;
• No portion of the new loan funds will be used for construction, rehabilitation or remodeling;
• All funds are paid directly to the borrower or to a third party to satisfy a valid lien against the property; 
• A survey exception is used, if the property is not included within an approved, surveyed land subdivision in accordance with local laws and regulations;
• The transaction does not fall within another category requiring underwriting approval; and
• The due diligence steps above are followed.

If your non-institutional lender transaction falls outside the above guidelines, specific Company underwriting approval is required. Please submit a Request for Approval to Issue Overlimits (Large) Policy or Extra Hazardous Coverage through policyapprovalrequest@stewart.com. Please also include a written explanation of the issues and the due diligence steps taken. 

General Requirements for Non-Institutional Lender Transactions involving Construction Loans and Multiple Beneficiaries 5 through 10

Underwriter approval is required where any of the following exist:

• The transaction involves property which has been the subject of recent construction, rehabilitation or remodeling, within the statutory lien period;
• Any portion of the loan funds is used for construction, rehabilitation or remodeling; these must be treated as construction loans. In this circumstance, the Company provides the following guidelines (in addition to regular construction underwriting guidelines):
  • Construction loans: 
    • "Good Priority" transactions under applicable state law are subject to incremental coverage requirements, i.e., the pending disbursement clause in P-8 and a mechanic's lien exception; 
    • "Broken Priority" transactions must include a mechanic's lien exception;
    • Loan policy coverage cannot exceed the loan amount; 125% coverage is not available.
    • See Bulletins MU2010007, MU2010008, MU2010009 and Virtual Underwriter 12.12.16.
• The number of the beneficiaries listed in the Deed of Trust or mortgagees in a Mortgage is more than four, but not more than ten. In this circumstance, the Company provides the following requirements: (See Bulletin SLS2009014). 
  • Multiple beneficiaries 5 through 10:  You must include the following Multi-Beneficiary Exception(s) in Schedule B of the Lender's policy or submit for underwriting approval: 
    • "Any impairment, loss or failure of title to the beneficial interest of the insured in the mortgage insured by this policy resulting from:

a. Lack of possession of the original promissory note secured by the insured mortgage; or

b. The absence from the original promissory note of a proper endorsement to the insured assignee;

c. Any claim, allegation or determination that the beneficial interest insured herein, or the underlying transaction involves the sale of a Security and/or is in violation of State or Federal Securities Laws.

For non-institutional construction loan transactions and transactions involving multiple beneficiaries 5 through 10, please submit a Request for Approval to Issue Overlimits (Large) Policy or Extra Hazardous Coverage through policyapprovalrequest@stewart.com along with a written explanation of the situation and the due diligence steps taken.  

If you have any questions relating to this or other bulletins, please contact a Stewart Title Guaranty Company underwriter.

For on-line viewing of this and other bulletins, please log onto www.vuwriter.com.