Loan Due Diligence Checklist
A complete, structured guide to reviewing any real estate loan before you sign. Built by Coventry Enterprises to give borrowers the same systematic analysis professionals use.
Why Due Diligence Matters More Than the Rate
Most borrowers spend their energy negotiating the interest rate. That is understandable. The rate is visible, easy to compare, and immediately intuitive. The problem is that the rate is rarely where a loan turns toxic. The danger is usually buried in provisions that borrowers skip because they are written in dense legal language buried on page 14 of a 60-page document.
Coventry Enterprises has reviewed hundreds of loan structures across residential and commercial real estate. The patterns are consistent. Borrowers who suffer serious harm from their loans almost always had early warning signs in their documents. The signs were there. They just did not know what to look for.
This checklist gives you a structured framework for reviewing every major category of loan risk before you sign. It is not a substitute for an attorney. For any significant real estate transaction, you should have qualified legal counsel review your loan documents. But this checklist tells you exactly which questions to ask, which provisions demand scrutiny, and which patterns signal a loan designed to harm rather than help.
The best time to use this checklist is when you receive the term sheet or commitment letter. The second-best time is at least a week before your scheduled closing. The worst time is at the closing table with a pen in your hand.
1. Basic Loan Terms
These are the fundamental parameters of the loan. Every number here should match exactly what was presented verbally and in any term sheet you received before applying.
| Item | What to Check | Red Flag |
|---|---|---|
| Interest Rate | Confirm the exact rate in the promissory note matches the term sheet and any verbal quotes. Note whether the stated rate is the note rate or the APR. | Rate in note is higher than quoted. "Subject to change at closing" language anywhere in the commitment. |
| APR | The Annual Percentage Rate must appear on the TILA disclosure (residential) or be calculable from the note terms (commercial). Compare APR to note rate to understand total fee load. | APR more than 1.5% above note rate on a standard loan indicates high fee load. Gap wider than 3% on a residential loan may trigger HOEPA high-cost thresholds. |
| Amortization Schedule | Verify the amortization period matches what was represented. A 30-year amortization with a 5-year balloon is very different from a 30-year fully amortizing loan. | Amortization period significantly longer than the loan term with no clear refinancing pathway. Negative amortization: payments do not cover interest. |
| Loan Term | Confirm the maturity date, any extension options, the conditions required to exercise extensions, and any extension fees. | Extension options that require lender approval at lender's sole discretion, giving the lender the power to force maturity default. Extension fees exceeding 1% per extension. |
| Balloon Payment | Identify the exact balloon amount and due date. Model out whether refinancing will be realistically available at that time based on projected equity, property value, and market conditions. | Balloon due within 3 years on a stabilizing commercial property. Balloon amount larger than the original loan amount due to deferred interest. No disclosed path to refinancing or loan payoff. |
2. Fee Audit
Fees are where lenders most commonly obscure the true cost of a loan. Compare every fee at closing against the Loan Estimate (residential) or the term sheet (commercial).
| Item | What to Check | Red Flag |
|---|---|---|
| Origination Fee | Identify the origination fee as a dollar amount and as a percentage of the loan. Compare against what was disclosed on the Loan Estimate or commitment letter. | Origination fee exceeding 2% on residential loans is high. Fees that increased from estimate to closing without a valid change-of-circumstance explanation are a RESPA violation indicator. |
| Discount Points | Confirm what rate reduction you are receiving per point paid. Calculate the break-even period. Points should be paying for a lower rate, not additional lender profit. | Points disclosed at closing that were not disclosed at application. Points charged without any corresponding rate reduction. More than 3 points total on a standard loan. |
| Broker Fees | Verify total broker compensation is disclosed and does not exceed what was agreed. Check for yield spread premiums or service release premiums on residential loans. | Undisclosed broker compensation. Broker fees that are split between lender-paid and borrower-paid in a way that inflates total compensation beyond the disclosed cap. |
| Closing Costs | Review every line on the Closing Disclosure against the Loan Estimate. Third-party fees (title, appraisal) should match; lender fees should not have changed without a valid reason. | Significant increases in lender fees between Loan Estimate and Closing Disclosure with no change-of-circumstance letter. Duplicate fees for the same service listed under different names. |
| Ongoing Fees | Review the note and loan agreement for any annual fees, administration fees, monitoring fees, or reporting fees charged throughout the loan term. These are common in commercial loans. | Ongoing fees that were not disclosed in the term sheet. Annual fees exceeding 0.25% of the loan amount on a commercial loan with no clear corresponding service. |
3. Rate Structure
For adjustable-rate loans, the current rate is the least important number. The reset mechanism determines what you will actually pay over the life of the loan.
| Item | What to Check | Red Flag |
|---|---|---|
| Fixed vs. Adjustable | Confirm which type you have in the actual promissory note. Some loans are marketed as "fixed" but contain adjustability provisions tied to specific trigger events. | Any rate variability provision in a loan marketed as fixed-rate. "Fixed for X years, then adjustable" structures without clear disclosure of the adjustment mechanism. |
| Index and Margin | Identify the specific index used (SOFR, Prime, CMT, etc.), the margin added to that index, and the frequency of rate adjustments. Calculate your rate at current index levels plus margin. | Proprietary or obscure index the lender can influence. Margins exceeding 4% above index. No clear definition of which index publication is used for calculation. |
| Rate Caps | Identify the periodic cap (max change per adjustment), the lifetime cap (max change from initial rate), and any payment caps. Calculate worst-case rate and payment under the lifetime cap. | No lifetime cap on a residential ARM. Periodic caps that allow very large jumps per adjustment period. Payment caps without rate caps, which leads to negative amortization. |
| Floors | Identify any rate floor provisions. A floor prevents the rate from falling below a minimum even if the index drops, limiting the borrower's benefit from rate decreases. | Floor set at the initial rate or higher, meaning the borrower bears all upside risk but gets no benefit from falling rates. Asymmetric adjustment: rate adjusts up quickly but down slowly. |
| Default Rate | Locate the default interest rate provision. Most loans specify a higher rate that kicks in upon default. Understand how much higher it is and what events trigger it. | Default rate exceeding 5% above the note rate. Default rate triggered by minor technical violations rather than payment failure. Default interest compounded to increase loan balance. |
4. Prepayment Analysis
Prepayment penalties trap borrowers who want to refinance or sell. Understanding the true cost of exit is as important as understanding the cost of holding the loan.
| Item | What to Check | Red Flag |
|---|---|---|
| Penalty Type | Identify whether the prepayment penalty is a fixed percentage, a step-down structure (declining over time), yield maintenance, or defeasance. Each has a dramatically different cost profile. | Yield maintenance or defeasance clauses on a residential loan or short-term commercial loan. Fixed percentage penalties that do not decline over time. Penalty described vaguely without a clear calculation method. |
| Duration | Identify how long the prepayment penalty period lasts. Calculate whether this period covers the entire likely holding period for the property or loan. | Prepayment penalty that lasts for more than 5 years on a residential loan. Penalty period that extends beyond the balloon payment date, trapping the borrower at maturity. |
| Calculation Method | Work through the penalty calculation with actual numbers. For yield maintenance, calculate the cost at current and likely future treasury rates. For step-down, model out the cost at each year. | Penalty calculation so complex that neither the lender nor the borrower can explain it in plain terms. Ambiguity in what "outstanding balance" means for penalty calculation (principal only vs. principal plus accrued interest). |
| Exceptions | Look for exceptions to the prepayment penalty: death, disability, sale of property (due-on-sale). Note whether refinancing with the same lender is exempt. | No exceptions for property sale. Penalty applies even if the borrower pays off the loan due to lender-initiated acceleration. No exception for death of individual guarantor. |
5. Default Triggers and Remedies
The default clause is where toxic commercial loans do their most serious harm. A broadly written default clause gives the lender the power to call the loan for reasons that have nothing to do with the borrower's ability to pay.
| Item | What to Check | Red Flag |
|---|---|---|
| What Triggers Default | Read the entire default clause. List every event that constitutes a default. Separate monetary defaults (missed payments) from non-monetary defaults (covenant violations, material adverse change clauses). | Non-monetary defaults with no materiality threshold. "Material adverse change" clauses defined vaguely or not at all. Defaults triggered by events entirely outside the borrower's control. |
| Cure Period | Identify the cure period for monetary defaults (typically 5 to 10 days for payment, 30 days for other monetary defaults) and non-monetary defaults (typically 30 to 60 days, sometimes with an extension to prosecute cure). | No cure period for non-monetary defaults. Cure period so short that practical cure is impossible for defaults requiring contractor work or regulatory action. Cure periods that shrink after the first default. |
| Acceleration | Understand what triggers automatic acceleration versus lender-option acceleration. Review whether acceleration is the only available remedy or whether the lender must exhaust other options first. | Automatic acceleration without any notice requirement. Acceleration triggered by defaults that are technical and not related to payment capacity. Waiver of any anti-deficiency protections. |
| Cross-Default | Identify any cross-default provisions. A cross-default means a default on any other obligation triggers default on this loan. Understand the scope: does it cover only other loans with this lender, or all obligations? | Unlimited cross-default covering all obligations including trade debt. Cross-default that extends to obligations of related entities or guarantors. No carve-out for technical defaults under other agreements being contested in good faith. |
| Guaranty Scope | Review any personal guaranty in detail. Distinguish between a full recourse guaranty, a limited recourse guaranty, and a "bad boy" or springing recourse guaranty. Understand exactly when guaranty liability attaches. | Full recourse guaranty on a loan marketed as non-recourse. "Bad boy" guaranty with a list of triggers so broad that ordinary business decisions could trigger full personal liability. Guaranty that survives loan payoff for an extended period. |
6. Lender Background
Who you borrow from matters as much as the terms. A lender with a pattern of aggressive enforcement, regulatory violations, or predatory practices can make even a reasonable loan dangerous.
| Item | What to Check | Red Flag |
|---|---|---|
| Licensing | Verify the lender and loan originator hold all required state and federal licenses. Use NMLS Consumer Access for residential lenders. For commercial lenders, check state banking regulator records. | Missing state license for the state where the property is located. Expired license. Loan originator not individually licensed. Lender refusing to provide license numbers upon request. |
| CFPB and State Complaints | Search the CFPB complaint database for the lender's name. Search your state banking regulator's public records. Note the volume of complaints and the nature of the issues raised. | High volume of complaints about the same practices you are being asked to agree to. Prior enforcement orders requiring the lender to change those same practices. Regulatory consent orders within the past five years. |
| BBB and Reviews | Review Better Business Bureau rating and complaint history. Search Google, Trustpilot, and real estate forums for borrower reviews. Look specifically for patterns, not isolated incidents. | Consistent complaints about bait-and-switch pricing, surprise fees at closing, or aggressive default enforcement. F rating or unresolved complaint pattern with the BBB. Very few reviews for an active lender (suggests review suppression). |
| Court Records | Search PACER for federal court cases involving the lender. Search your state court's public records. Look for patterns of foreclosure actions, lender liability suits, and regulatory enforcement cases. | Multiple borrower-filed lawsuits alleging predatory lending or fraud. Pattern of aggressive foreclosure actions on loans that did not appear to be in serious default. Prior judgments against the lender for lending violations. |
7. Collateral and Security
The collateral provisions govern what the lender can take and how quickly they can take it. Problems with title, appraisal, or lien position can surface long after closing in the worst possible circumstances.
| Item | What to Check | Red Flag |
|---|---|---|
| Appraisal Review | Obtain and read the full appraisal, not just the cover page. Check the comparable sales used, the methodology applied, and whether the appraiser is independent from the lender. | Appraisal ordered by the lender from an appraiser they repeatedly use. Comparable sales that are not truly comparable in location, condition, or timing. Appraised value that conveniently meets the minimum required for loan approval. |
| Title Review | Review the title commitment carefully. Identify all exceptions listed in Schedule B. Understand which exceptions will remain after closing and what risk they create. | Mechanic's liens, judgment liens, or HOA liens that are not being resolved at closing. Easements or encroachments that affect the property's use or value. Gaps in chain of title that were not addressed. |
| Lien Position | Confirm the lender's lien will be in the priority position represented. For commercial loans, verify that any senior liens are being paid off or subordinated. Understand all liens that will survive closing. | Lender claiming first position without a full payoff of existing mortgage at closing. Undisclosed subordination agreement or intercreditor agreement limiting lender's enforcement rights in ways not disclosed to borrower. |
| Insurance Requirements | Review the loan agreement's insurance requirements: coverage types, minimum amounts, loss payee designations, and what happens if insurance lapses. Confirm current coverage meets these requirements before closing. | Insurance requirements that exceed what is commercially available or reasonably affordable. Lender self-placement of force-placed insurance at extremely high cost with affiliate insurers. No grace period before force-placement after lapse. |
| Cross-Collateralization | Identify any cross-collateralization provisions that would make other properties security for this loan. This is common in commercial portfolio lending and dramatically expands the lender's remedies upon default. | Undisclosed cross-collateralization. Blanket liens that extend to property the borrower owns free and clear. Cross-collateralization that encompasses the borrower's primary residence for a commercial loan. |
When to Walk Away: Absolute Deal-Killers
Some provisions are not negotiating points. They are signals about a lender's intent, and no interest rate discount justifies accepting them. If you encounter any of the following, walk away from the transaction regardless of how much you want the property or need the capital.
- Non-monetary default clauses with no materiality threshold and no cure period. These give the lender the power to declare default and accelerate the loan based on subjective judgment with no opportunity for the borrower to fix the issue.
- Prepayment penalties that extend to or past the balloon payment date. This makes voluntary exit impossible and means the lender profits from your failure either way: through prepayment penalties if you pay off early, or through default proceedings if you cannot refinance the balloon.
- An unlicensed lender or one with prior fraud convictions. A lender who cannot demonstrate proper licensing is either incompetent or deliberately operating outside regulatory oversight. Neither is acceptable for a real estate loan.
- Provisions requiring waiver of federally mandated disclosure rights. Any lender asking you to waive TILA rights, RESPA rights, or other federal borrower protections is acknowledging that they do not intend to comply with those protections.
- Closing pressure that prevents document review. A lender who insists on closing within 24 to 48 hours of sending final documents is using time pressure as a substitute for legitimate lending. Legitimate lenders allow adequate review time.
- Undisclosed third-party fees discovered at the closing table. Fees that appear at closing without prior disclosure indicate that the lender deliberately concealed costs from you. This is a strong indicator of predatory intent and may violate RESPA.
- Full personal recourse guaranty on a transaction represented as non-recourse. This is not a drafting error. If a transaction was presented as non-recourse and the documents contain a full recourse guaranty, the lender has misrepresented the transaction. Stop the closing immediately and consult an attorney.
Due Diligence FAQ
When should I do loan due diligence?
The ideal time is before you sign the term sheet or commitment letter, not at the closing table. Once you are at closing, the pressure to sign is enormous and your leverage is minimal. Review the checklist as soon as you receive a full loan proposal, and have an attorney review the actual loan documents before closing. Earlier is always better.
Do these due diligence items apply to commercial loans as well as residential?
Yes, with important modifications. Commercial loans have fewer mandatory federal disclosures than residential loans, so the checklist items around fee disclosure and rate structure become even more critical when a Loan Estimate is not required. Commercial loan documents are often much longer and more complex, and provisions like cross-default clauses, cash management triggers, and recourse carve-outs require careful legal analysis. For any commercial transaction, an attorney experienced in commercial real estate lending is not optional.
What is a cross-default clause and why does it matter?
A cross-default clause means that defaulting on any other obligation can trigger a default on this loan. For example, if you have multiple properties with the same lender or affiliated lenders, a default on one loan can automatically trigger default on all of them. For commercial borrowers with portfolio financing, cross-default clauses can turn a problem on one asset into a catastrophic collapse of an entire portfolio. Always identify and negotiate the scope of cross-default provisions before signing.
How do I check if a lender is properly licensed?
The NMLS Consumer Access website at nmlsconsumeraccess.org allows you to look up mortgage companies and individual loan originators by name or license number. For commercial lenders who may not be subject to NMLS licensing, check your state's banking or financial institutions regulatory agency website. Also search the CFPB's enforcement action database and your state attorney general's public records for any prior enforcement actions against the lender.
What should I do if I find a major red flag in my loan documents?
Do not sign. Ask the lender to explain the provision in writing. Then consult with a real estate attorney before proceeding. Some red flag provisions are negotiable; others are deal-killers that reflect the lender's fundamental approach to borrower risk. Knowing which is which requires legal advice specific to your transaction. If the lender pressures you to sign without allowing time for legal review, that pressure itself is the most serious red flag of all.
Need Help Reviewing Your Loan?
Coventry Enterprises offers educational consulting on loan document review. We help you understand what you're reading, identify dangerous provisions, and know the right questions to ask before you sign.
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