Estoppel – Is Balance Verification Important?

Whether you are purchasing an existing seller held Real Estate secured instrument such as a mortgage, trust deed, land contract, etc., for your own portfolio or attempting to broker it to an investor When one purchases such an instrument you should realize that the actual outstanding balance owed on the instrument may vary depending on what the Note holders (payees) tell you as oppose to what the Note makers (or payors) feels is representative of their balance owing.

Depending on the degree of discrepancy if any that may exist between what the Note holders and Note makers feel is an accurate representation of the balance could impact the ultimate “pay price” you or an investor will fund for the instruments purchase.

We have seen all too often Note holders and Note payors using ill prepared amortization schedules to track their obligation. Payors often send in extra funds above and beyond the required installment payment which causes additional principal reduction to take place and which may not be accounted for or represented in the balance outstanding. From time to time there may have been some credits given to Note payors for repairs, “sweat equity”, etc. that were performed by the Note payors but not readily discernable by reviewing the Mortgage or Note documents.

We've encountered again and again this scenario; a well seasoned 11% interest rate Note instrument payable $558.66 in principal and interest per month had the transaction closing date and the $57,000.00 Note instrument dated 1-12-1993 and the Note instrument called for its initial payment to also begin on the Note just a few short days later on 1-15-1993. After 113 installments went by from 1-15-1993 through 5-15-2002, instead of the Note having an outstanding principal balance of $49,882.96 as the Note holder and Note payors thought, the correct principal balance on this Note was $48,576.27.

This represents a difference of $1,306.69! With the Note instrument calling for the initial Note installment payment to be made on virtually the same day the closing took place, unbeknownst to these parties the majority of that installment payment went towards direct principal reduction as opposed to it being considered interest due on the Note. These are just a few of the scenarios that can crop up and cause balance discrepancies. Please recognize that disputed balances between parties are the exception rather than the rule but they can and do happen. Remember the Note holders who are anticipating a cash payout to themselves have little incentive to disclose a lower than usual balance.

To protect themselves some investors insist on utilizing an instrument known as an “estoppel certificate” which is:

A signed statement by a party such as a tenant, mortgagor, or mortgagee certifying for the benefit of another party that a certain statement of facts is correct as of the date of the statement. Delivery of the statement by such a party prevents (estops) that party from later claiming a different state of facts.

An estoppel asks both the payor and payee to acknowledge in a written format what the instruments outstanding balance is, what the terms of repayment are, that there are no undisclosed or gratuitous credits that exist, and that all payments are current with no offsets or defenses to future payments involved. By having both parties execute an estoppel certificate you have assured yourself and your investor that all parties are in agreement regarding the instruments repayment terms and loan balance.

One of the inherent dangers in sending out an estoppel request to your Note payors is that once they receive such a formal notice, “Pandora's box” is opened as they now become acutely aware of the Note sellers (Payees) intentions to sell their loan. On occasion, the Note payors will become non cooperative, and attempt to thwart the sale of the instrument by the Note holders. In some instances they will try to work their own deal with the Note holders so that they can take advantage of buying back their own debt at a discounted amount thereby circumventing you and your services.

So, if you are making a Note investment you need to determine whether you really want to open up this proverbial “Pandora's box” with the Note payor by sending out an estoppel. At the very least it's probably a good idea to speak to the Note payors and conduct what some call a “verbal estoppel” to in fact determine;

A) That they are not fictitious and do in fact exist.

B) That they verbally acknowledge the debt obligation and its repayment terms, balance, etc.

C) That they don't disclose to you any tell tale signs that they may problems waiting to surface with regard to the property, the loan terms, or their future ability to repay the debt.

Remember after the closing with the Note seller's takes place and they have been disbursed their funds, it's far more difficult to correct discrepancies when setting up an account that was sold to you.