Due diligence has a reputation as a feeling — a sense that the people involved seem competent, the numbers look reasonable and the property is in a decent area. It is not a feeling. It is a list of questions whose answers either exist in writing or do not, and the discipline is to ask all of them in the same order every time, including on the deal that looks obvious. Especially on the deal that looks obvious.
A mortgage investor is underwriting four things at once: the property that secures the loan, the borrower who is supposed to service it, the paper that creates and protects the charge, and the people who arranged the loan and will administer it. A weakness in any one of them can produce a loss out of a position that looked sound on the summary sheet. The checklist below is organised that way.
1. The security — the property
Everything else is a second line of recovery. If the loan stops performing, what you hold is a legal claim against one specific piece of real estate, so the first question is always what that property is worth and how quickly somebody else would buy it at something near that price.
- The appraisal. Who instructed it, who paid for it, what date it carries, and whether the value is as-is or as-complete. An as-complete value on an unfinished building is a forecast, not a valuation.
- The basis of value. Comparable sales, income approach or cost approach — and whether the comparables are genuinely comparable in size, age, zoning and location.
- Marketability. How long comparable properties sit on the market in that area. A rural acreage, a special-purpose building or a property with one plausible buyer is a different risk from a semi-detached house in a dense suburb at the same loan-to-value.
- Condition and occupancy. Owner-occupied, tenanted, vacant, or mid-renovation. Each changes both the value and the practical cost of recovering it.
- What ranks ahead of you. Prior charges, realty tax arrears, condominium common-expense arrears, construction liens and writs of execution. Priority is a question of registration, not of intention.
The equity cushion, written out
Loan-to-value is usually quoted against an appraisal, which is not the number you would recover. Running the arithmetic through to a net recovery is the single most useful thing an investor can do with a deal summary.
- Appraised value: $1,000,000. A placeholder, chosen for round arithmetic.
- Existing first charge: $650,000. Your second charge: $100,000. Total debt $750,000, a combined loan-to-value of 75%, and an apparent cushion of $250,000.
- Realisation 10% below appraisal: $900,000. A sale under time pressure is rarely a sale at the appraised figure.
- Selling and enforcement costs of 8%: $72,000. Net proceeds $828,000.
- Debt grown to $780,000 by arrears interest, legal fees, insurance and property taxes advanced to protect the charge. Recovery above the debt: $48,000.
Both charges are repaid in full, so on paper nothing went wrong. But the $250,000 cushion that appeared on the summary sheet was worth $48,000 by the time the money actually moved. Shift the realisation discount from 10% to 20% and the second charge is impaired. That is the whole argument for caring about marketability as much as about the loan-to-value ratio.
2. The borrower
Private mortgage lending is not credit-score lending, which is sometimes misread as meaning that the borrower does not matter. The borrower matters a great deal: a loan that performs for its whole term costs nothing to recover, and the borrower is the only person who can make that happen.
- Who the borrower actually is. An individual, a numbered company, a partnership, or a corporation with no assets other than the property. The answer determines who you can pursue beyond the security.
- Whether there is a personal covenant or guarantee, and whether the guarantor has anything attachable. A guarantee from a person with no assets is a document, not a protection.
- Where the monthly payment comes from. Employment income, rent, business cash flow, or an interest reserve funded out of the advance — which is the loan paying itself for a while.
- The exit. Sale, refinance, construction completion or inheritance. Every private mortgage is a bet on a specific exit happening before maturity, and a vague exit is the most common reason a short loan becomes a long one.
- The searches. Prior defaults, judgments, executions and bankruptcy history.
3. The paper
The legal file is where diligence either gets documented or quietly does not. Each item below proves something specific, and a file missing one of them has a gap in a particular place rather than a general air of informality.
| Document | What it proves | What to check |
|---|---|---|
| Appraisal | What the security is worth | Date, as-is versus as-complete, who instructed it, and the appraiser's designation and independence |
| Title search or parcel register | What ranks ahead of your charge | Registration order, prior charges, writs of execution, easements, liens and any notice on title |
| Title insurance policy | That certain title defects are covered | That the insured amount covers your principal and that the policy names the correct charge holder |
| Property and fire insurance | That the asset survives a physical loss | That the mortgagee clause names the charge holder, the coverage is replacement cost, and the policy is in force |
| Commitment and registered charge | The terms you will actually be paid on | Rate, term, payment dates, default rate, prepayment terms, maturity date and any renewal mechanics |
| Solicitor's report on funding | That the money went out as agreed and the charge registered as promised | That advances match the commitment and that the registered priority is the priority you were sold |
4. The people
On a pooled investment you are not reviewing a single mortgage; you are reviewing the process that produces mortgages and the organisation that will administer them. Ask who underwrites, who signs off, who holds the money, who services the loan, and whether mortgage administration is a licensed activity in the province where the mortgages sit — licensing requirements differ by province and have changed recently in more than one of them. Ask what reporting you will receive and how often, and what happens to administration of the loan if the manager stops operating.
Two questions that do most of the work
- May I see the appraisal, the title search and the insurance binder in full, before funding — not summarised in a deal sheet?
- If this loan stops paying on the first day of the term, who does what, in what order, who pays for it, and out of whose money?
The answers are useful. So is the manner of answering. A file that can be produced on request is a file that exists; a question that is redirected to a track record or a historical return figure has been answered, just not in the way it was asked.
Due diligence is not a judgement about whether a deal feels right. It is a set of documents that either exist or do not, and a set of questions that are either answered or deflected.
Questions investors ask
Can I do this level of due diligence on a pooled mortgage investment?
Not loan by loan — you will not see every file. What you review instead is the process and the book: the lending policy, the weighted-average loan-to-value, the position and geographic mix, the arrears schedule, the fee load and the redemption terms. The questions change from "is this property worth it" to "does this operator do consistently what it says it does".
How recent does an appraisal need to be?
Recent enough that the market it describes is the market you would sell into. There is no universal number, and in a moving market a valuation several months old on a thin-market property is materially less useful than the same age of report on a standard suburban house. Ask for the date and judge it against the property type.
Is title insurance a substitute for a title search?
No. They do different jobs. A search tells you what is registered against the property and in what order, which is how priority is established. Title insurance covers certain defects and losses after the fact, within the limits of its policy. Neither replaces the other.
Does it matter if the borrower or the broker ordered the appraisal?
It is worth knowing. An appraisal instructed by a party with an interest in a high value is not automatically wrong, but it is a reason to read the comparables rather than only the conclusion, and a reason to ask whether the lender or administrator can instruct its own.
Does a personal guarantee make a mortgage safe?
No. It adds a second avenue of recovery, which has value only to the extent the guarantor has assets that can be reached and a judgment can be enforced against them. Some provinces also restrict recovery on the personal covenant after certain enforcement routes. Treat a guarantee as an addition to the security, never as a replacement for it.