In my most recent post I outlined some of the more common questions I receive when explaining that my company, Seasoned Funding, LLC invests in Non-Performing Mortgage Notes. (You can read that post by clicking here.)
Part II of the 101 Guide to Investing in Non-Performing Notes is focused on explaining how we invest in defaulted mortgage notes and summarizes what happens once we buy the note. As I mentioned in the first post, this is the 101 Guide to Investing in Non-Performing Notes and is meant to be a simple explanation for someone who is unfamiliar with this industry. If you enjoy what you read here or are interested in finding out more, take a look at some of our past posts or contact us to find out how to work with us in the future. We’ve had large amounts of training, education, and practice in this field and understand the in’s and out’s that aren’t explained in detail here.
Where do you buy these notes/assets?
As trivial as it sounds, the average banker and most mortgage lenders have no idea that this niche of investing exists, nor can they point you in the direction of loan sales for their bank. It would be great if I could simply walk into a bank and ask for a list of their defaulted loans, but in reality only a handful of people from each regional/national branch handle the sale of notes (a small branch or bank may only have one person handling these sales).
With that being said, relationships can be built with the person in charge of bank NPN sales, but is typically done over phone or email and rarely has success. Most banks sell their assets in bulk (1-5 million +) to private funds that then sell them off for a slightly higher price to individual investors such as myself.
We purchase most of our assets from small private entities for around 35 – 55 cents on the dollar. Pricing expectations are typically based off of the Unpaid Principle Balance (UPB) or the Current Market Value (CMV) of the property securing the note.
Once you buy the note what happens next?
This is a multifaceted process that can take on many shapes depending on the borrower’s current condition and needs. I like to boil down our “workout” options to 3 main strategies although there are many more:
- Modifying the Loan
This means we take the current mortgage loan and promissory note and modify the terms to meet the borrowers current capabilities. This can be a modification in term (timeline of repayment), raising/lowering the percentage of the previous/current interest rate, adding legal fees/arrearages (back payments), or doing a principal balance reduction. The most important element in getting a successful modification is finding out why the borrower defaulted in the first place, and reassessing what they are capable of paying now. *Modifications are a passive form of investment. As cliche as it may sound, when we modify a loan and get the borrower successfully repaying, it is truly a win-win situation. The borrower is able to stay in their home and build back their credit while we passively collect their monthly payments, including interest, over an extended period of time. I also enjoy the fact that since we are not the “Home Owner” there are little to no responsibilities once the borrower/home owner is successfully repaying. No need to worry about repairs, maintenance, or vacancies. I love asking my inquisitors, “When you’re a homeowner and your toilet breaks do you call the bank to have them fix it?” No way! It is TRUE passive income!
- Deed In Lieu of Foreclosure (DIL)
This exit strategy can be a great solution for homeowners who have moved on from their debt and are ready to leave it behind them. Often times the borrowers have already moved out or may have inherited an unwanted property/debt. A Deed In Lieu of Foreclosure is a deed instrument (a legal document that passes ownership, right, or interest to) in which the borrower grants the lender all interest in the real property. In return, the lender releases the borrower of their remaining debt. Essentially the lender gains title to the property in return for absolving the borrowers remaining unpaid debt. If a DIL appears to be the best option getting one can happen quickly and inexpensively. It can typically be written up by an attorney for around $300- $350. Many homeowners are unaware of this option and feel there is no other way out of their debt than foreclosure. A DIL can be a tremendous opportunity for both the borrower and lender. The lender is able to acquire the property at a much faster rate than traditional foreclosure (for much less cost as well) and the borrower is able to move on with their life, leaving their debt behind them! Not to mention, you do not have to report anything to credit bureaus or agencies as you would in a foreclosure that could further worsen the borrowers credit.Thus, a DIL option is not always the best solution. If a property has various liens or judgements (a lien that attaches to your property without your approval) providing a DIL can be an issue. Second mortgages, unpaid taxes, code violation liens, or judgements need to be taken care of prior to getting a DIL. If the borrower or the lender does not pay these or get a release, a foreclosure is the only way to “wipe” the debt from subordinate lien holders in order to clear title.
When people hear that someone has defaulted on their mortgage, their initial thought is foreclosure. In most states, and this is definitely the case in Florida, foreclosure is a long, costly, and daunting experience. Luckily, on average, foreclosure is executed about 20% of the time as a means of an exit strategy. Foreclosure is typically carried out when the borrower simply has no desire to work with the lender in a modification or Deed in Lieu. It can also happen if a DIL is not a viable option. In this instance, the lender can initiate a “friendly foreclosure” in which the borrower does not contest (fight) the foreclosure. This greatly shortens the timeline of the foreclosure process. It is important to understand that every state is different and the process of foreclosure and laws vary from state to state. Knowing the laws of the states you are investing in is extremely important and no workout should be done without consulting an expert/attorney in that region or market.
After you modify the loan or get title to the property, what happens next?
If a successful modification is produced, we hold the note in our portfolio, until the borrower satisfies (pays off) the mortgage in full, sells the property, or refinances. This could be 5 years from now or up to 30 years.
There are also many creative solutions that I won’t discuss in my 101 guideline such as partials or selling the note as a re-performer that can yield high return on investment (ROI) in shorter periods of time.
If I gain title to the property either by DIL or foreclosure I can sell the property on the retail market using a realtor or to an investor for a “short term” cash-out. Another alternative is keeping the property as a rental or create an owner financed note to create a more “long-term” passive investment.
Either way, money is coming into my favorite bank, me.
What’s the catch?
We’re typically asked “what’s the catch?” or “what’s the negative?” after explaining how we make a profit with non-performing notes. To be honest, there really is no “catch”. If your educated in the due diligence process and purchase the assets at the right price there very rarely is a negative side.
In our most recent investment, we purchased a note with two of our private investors in Orlando for $17,750. The property value was priced at $50,000 in great condition and $45,000 quick sale price. The unpaid balance (UPB) on the property is $62,950.
Because we bought the note at 36% of Current Market Value and 28% of the UPB there is an enormous amount of profit to make regardless of the exit strategy. THAT’S WHY THERE IS NO CATCH!
So there it is. The 101 Guide to Investing in Non-Performing Notes. I hope this helps you have a clearer understanding of the basic aspects of investing in Non-Performing Notes.
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