Are you worried the buyer won’t make the monthly payments?

If so, you’re certainly not alone. This is a common concern of sellers offering owner-financing. And it should be, since an owner-financed note is very often one of the seller’s most valuable financial assets. Unfortunately, all too many sellers fail to protect their asset when it comes to one of the most important tasks … verifying that hazard insurance is in place and property taxes are current.

Next to delinquent payments, failure to maintain an insurance policy and/or pay property taxes in a timely manner are the two most common reasons a buyer defaults on their note. In fact, it’s common for buyers to make their monthly principal and interest payments while at the same time neglecting to pay their insurance premiums or annual property tax invoice.

As you can certainly imagine, a lapse in hazard insurance coverage can be devastating to both the buyer/borrower and the note holder. If a fire results in a significant or total loss to an uninsured property, the note holder will more than likely never see another payment from the buyer. They will be left to foreclose on a property that’s worth much less than the unpaid balance on the note. The costs associated with getting the damaged property back will painfully add to the already significant financial loss.

If a buyer gets far enough behind on paying the real estate property taxes, the county has a legal right to sell the property at auction. In most states, the lien for county property taxes takes precedence over a mortgage note holder’s position, leaving an unsuspecting lender high and dry. Imagine finding out that you’ve lost all rights to your collateral because the property’s been sold out from under you by the county! That would not be a good day.

The good news is that both of these serious problems can be easily avoided with just a little effort.

First, when creating a promissory note be sure that it spells out the borrower’s obligations to maintain adequate hazard insurance and to pay the property taxes on time (among their other responsibilities). After the sale, the note holder must be diligent to periodically verify that the homeowner’s insurance policy is current and the property taxes are paid as required by the county.

Require the buyer to send you a copy of the insurance policy’s declaration page every year, and confirm that the buyer is listed as the insured owner and that you, the seller, are listed as the mortgagee or loss payee. Next, call the insurance company to verify that the policy information you have is correct and that the premiums are up-to-date. As the mortgagee listed on the policy, you should receive notice of any cancellation that occurs. Nevertheless, it’s safer to verify on or before premiums are due from the buyer.

To verify that property taxes are current, simply check the county records online at the appraisal district’s web site. You should be able to search for this public information using the property address or tax parcel identification number. If online access isn’t available in the county, call or visit the county tax assessor’s office to verify this important information.

As mentioned above, most loan documents require the buyer to keep taxes and insurance current. Failure to do so typically constitutes a default under the provisions of the promissory note or security instrument. Note holders can demand that the default be cured immediately and/or start foreclosure proceedings. In order to protect their collateral, note holders also have the authority to pay delinquent property taxes and, after proper notice, to “force place” hazard insurance on a property. These expenses can then be charged back to the borrower as described in the terms of the actual note, mortgage, deed of trust, or contract.

Savvy sellers choose to avoid the headache of monitoring insurance and property taxes altogether by setting up a reserve/escrow account through a third-party servicing agent. Under this arrangement, the buyer pays an amount equal to one-twelfth of the annual property tax and homeowner’s insurance premium amounts each month when they make their principal and interest payments. The third-party servicer pays the insurance company and county tax assessor from funds in this escrow account.

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