Why Due Diligence on Loan Terms Matters as Much as Property Due Diligence
Real estate investors understand property due diligence. Inspect the property, review the financials, verify the leases, check the environmental history, confirm zoning. These steps are standard practice for anyone who has completed more than a couple of real estate transactions. But the same rigor is rarely applied to the loan that will finance the acquisition. Borrowers often spend days on property due diligence and hours — or sometimes minutes — on loan due diligence.
This imbalance is expensive. A property that has a deferred maintenance issue costs money to fix. A loan that has a problematic prepayment provision, an inadequate interest reserve, or a balloon provision without a realistic exit path can cost significantly more and create problems that are much harder to resolve than a leaky roof or an HVAC replacement.
Coventry Enterprises applies the same systematic rigor to loan due diligence that good property investors apply to property due diligence. This checklist covers the major elements of that review process, providing borrowers with a framework for understanding what needs to be examined before any real estate loan is signed.
Section 1: Basic Loan Terms Verification
The first section of the loan due diligence process verifies that the basic stated terms of the loan are accurate and complete.
Interest rate verification. What is the exact interest rate? Is it fixed for the full term or does it adjust? If it adjusts, what index does it use, what is the margin added to the index, and what are the adjustment caps? A loan described as "7.5% fixed" should have a loan agreement that clearly states the interest rate is fixed at 7.5% for the full loan term. If the agreement says "7.5% initial rate adjusting after three years," that is a very different product.
Loan amount and disbursement. What is the total loan amount? For construction loans, how is the loan amount disbursed — all at closing, or through a draw process? If a draw process, what are the draw conditions and timing?
Amortization period and term. What is the amortization period (the period used to calculate monthly payments) and what is the actual loan term (when the loan matures)? If these are different — 25-year amortization with a 7-year term is common in commercial lending — the balloon payment at the end of the 7-year term needs to be calculated and understood.
Monthly payment amount. Calculate the expected monthly payment independently and verify it against what the lender has stated. Errors in payment disclosure, while uncommon, do occur and are better caught before closing.
Section 2: Fee and Cost Verification
The second section verifies all fees associated with the loan to ensure the total cost is accurate and complete.
Origination fees. What origination fees does the lender charge, expressed in both dollar amount and percentage of the loan? Fees above 2-3% of the loan amount for conventional products or above 3-4% for non-conventional products warrant scrutiny and explanation.
Other lender fees. Underwriting fees, processing fees, documentation fees, rate lock fees — list all of them separately and add them to the origination fee to get the total lender fees at closing. This complete picture is what matters, not just the origination fee in isolation.
Third-party fees. Appraisal, title insurance, escrow, and other third-party fees are not lender fees but are part of the cost of obtaining financing. The Loan Estimate for residential loans (where it is required) summarizes these. For commercial loans, borrowers need to compile this information themselves from multiple sources.
Total cash to close. Add the down payment (if purchasing), lender fees, and third-party fees to calculate the total cash required at closing. Knowing this number accurately before closing is essential for financial planning.
Section 3: Prepayment Provisions
The third section analyzes the prepayment structure — the provisions that govern what happens if the borrower wants to pay off the loan before its maturity date.
Prepayment penalty existence and structure. Does the loan have a prepayment penalty? If so, what type — a step-down penalty (decreasing over time, such as 5-4-3-2-1%), a flat percentage, a yield maintenance provision, or a defeasance requirement? Each of these structures has different cost implications and different implications for the borrower's flexibility.
Lockout period. Is there a period during which prepayment is not allowed at all? CMBS loans often have lockout periods where the borrower literally cannot pay off the loan regardless of willingness to pay a penalty.
Prepayment window. Is there a period near maturity during which the loan can be paid off without penalty, sometimes called an open window? Knowing when this window is can affect the timing of a sale or refinance decision.
Investment strategy alignment. Does the prepayment structure fit the investment strategy? A five-year hard prepayment penalty on a loan for a property the investor plans to sell in three years is a significant problem. This alignment check is part of every Coventry Enterprises loan review. More detail on problematic prepayment structures is available on the toxic loans page.
Section 4: Recourse and Personal Guarantee Analysis
The fourth section examines the personal liability structure of the loan.
Full recourse vs. non-recourse. Is the loan full recourse (borrower personally liable for the full debt), limited recourse, or non-recourse (lender recovery limited to the property)? This designation needs to be in the actual loan documents, not just described verbally during the sales process.
Carve-out provisions. For loans described as non-recourse, what are the carve-outs — the circumstances that would create personal liability despite the non-recourse designation? Standard carve-outs for fraud and environmental liability are expected. Carve-outs for more ordinary events (failing to maintain insurance, allowing unpermitted transfers) can effectively convert a non-recourse loan into a full recourse loan in many realistic scenarios.
Guaranty documents. If there are separate guaranty agreements, review them independently from the loan agreement. The scope of the guaranty — what events trigger it, what assets it covers, what its duration is — needs to be understood as clearly as the loan's core terms.
Section 5: Exit Strategy Confirmation
The fifth section confirms that a realistic exit strategy exists for the specific loan structure being evaluated.
Balloon payment planning. If the loan has a balloon payment, when does it come due and what is the expected balance? Is there a realistic path to refinancing or selling the property before or at the balloon date? This path needs to be more than an assumption — it needs to be grounded in current lender availability for the property type and the borrower's financial profile.
Extension options. Does the loan provide any extension option if the borrower cannot refinance at maturity? What does the extension cost? An extension option does not solve a balloon problem but it provides important flexibility and reduces the risk of a forced default.
Sale flexibility. If the investment strategy may include a sale before the loan matures, is the prepayment structure consistent with that flexibility? A property that becomes highly valuable and desirable to sell within three years should not have a three-year hard prepayment penalty that makes the sale economically painful.
Section 6: Covenant and Ongoing Obligation Review
The sixth section reviews ongoing obligations the borrower must meet throughout the loan term.
DSCR covenants. Does the loan require the property to maintain a minimum DSCR ratio? What happens if the property's income falls below the threshold? Does this trigger a technical default even if payments are current?
Insurance requirements. What insurance coverages and limits does the lender require? Are they consistent with what the borrower currently carries or plans to carry?
Additional lien restrictions. Does the loan restrict the borrower from placing additional liens on the property, taking out second mortgages, or transferring ownership interests? These restrictions can limit the borrower's financial flexibility significantly.
Reporting requirements. Does the lender require periodic financial reporting — income statements, rent rolls, operating statements? Are these requirements feasible given the borrower's property management structure?
Common Issues Coventry Enterprises Finds in Loan Reviews
After applying this framework to many loan reviews, Coventry Enterprises has a clear picture of the most common issues identified. The three that appear most frequently are: prepayment provisions that are more restrictive than the borrower understood, balloon terms with inadequate exit strategy planning, and personal recourse carve-outs in supposedly non-recourse loans that create broader personal liability than the borrower anticipated.
The due diligence process described in this checklist catches these issues before signing. Catching them after signing is more expensive and the options are more limited. Independent loan consulting from Coventry Enterprises applies this framework systematically to every loan reviewed, providing borrowers with the complete picture they need to make informed decisions.
To get a consultation on a specific loan, contact the firm through the contact page. For more detail on specific loan types and their common issues, explore the loan types page, the commercial real estate consulting page, and the private lending review page. The complete FAQ is available at the FAQ page.