Frequently Asked Questions When Buying
Non-Performing Notes
What are "sub-performing" and "non-performing" loans?
Sub-performing loans
Often called a "high maintenance" account--that is an account that requires a tremendous amount collection effort in order to reason, cajole, harangue, and beseech the tardy borrowers to make their payments month in and month out.
In some cases there may be rolling late payments, back payments already added to the outstanding principal, or an existing forbearance agreement between the lender and the borrowers to stave off a foreclosure.
Non-performing loans
These are accounts where attempts to collect have been unsuccessful and the account is simply not paying at all. It is in arrears with back payments and other expenses due.
Lenders are often in need of cash liquidity are willing to steeply discount the amount they will accept for the sale of their sub-performing or non-performing loan accounts (the promissory notes). These problematic accounts are a drain for the lender both monetarily and from a human resources standpoint. The more non-performing loans on a bank’s portfolio the less money that the bank can loan out which is why many banks have gone out of business…their bad loans have choked off their ability to lend money which is the life blood of any lending institution.
For smart real estate investors, opportunities can be created by acquiring these loans that are secured by real estate, which can then be "scrubbed" up and become performing again or simply foreclose and repossess the collateral securing the loan. Lenders sell these notes to create liquidity and get these loans off their books. The buyers of these notes can either modify the loan to make it more affordable to the borrower, foreclose on the property and then either sell it or manage it (in the case of commercial notes), or have the borrowers list the property and sell it as a short sale.
What do I offer or look at when I’m looking to buy a bank note?
Discount
The longer that a note is in default or non-performing, the bigger the discount or rebate that the bank will give. This is often called “color” in the industry. If a note is 30 days or less late, expect to pay around 90 cents on the dollar. 60 days late, it drops it to around 80 cents on the dollar. At 90 days, it is around 70 cents. After 90 days, the discounts increase rapidly. Take the discount into consideration along with the area of the property, market conditions (you would pay a lot less for a note in Detroit, MI then when compared to Austin, TX) and property condition. As there is a lot of severely defaulted notes out there, the general guideline is to offer around 40 cents on the dollar for residential and around 60 cents on the dollar (based on Fair Market Value) for your initial bids. You will also get a larger discount if you are buying a bulk order of notes instead of a individual note.
ALLONGE: An allonge is attached to the original note and states that the note should be paid “to the order of” the buyer of that note. It does not get recorded, unlike an Assignment of Mortgage/Deed-of-Trust.
ASSIGNMENT: When a lender sells its note and mortgage or deed of trust to another investor, the transfer of ownership of the mortgage or deed of trust is confirmed by the signing (and the recording at the county recorder’s office) of an Assignment of Mortgage/Deed-of-Trust.
BANKRUPTCY: Can be either a Chapter 7, 11 or 13. 7 and 13 are personal bankruptcies. 11 is a corporate bankruptcy. In all cases, a bankruptcy filing is when a debtor (borrower) seeks protection from creditors (banks/lenders) and has a Trustee appointed to help him/her pay those creditors off. For a lender, a bankruptcy involves extra fees and extra time in order to work through the Bankruptcy court and to convince the Trustee to allow the lender to continuein a foreclosure proceeding, for example.
COLLATERAL: This refers to the security that a lender requires from a borrower against a Note. The collateral for a
Mortgage or Deed of Trust is a borrower’s home.
DEED-IN-LIEU: When a borrower is in foreclosure, the foreclosing lender can offer the borrower to deed title to their home over to the Lender IN LIEU of foreclosing on
the borrower.
DEED OF TRUST: Similar to a Mortgage except it is a 3-party rather than 2-party agreement, wherein a Trustee holds a
power of sale on the property.
DEFAULT: When a borrower breaches or breaks any covenant or agreement in a Deed of Trust or Mortgage, which includes prompt payments, they are considered in
default of their Mortgage or Deed of Trust.
EQUITY: The part of the value of a home that is not encumbered, or secured by a Mortgage or Deed-of-Trust. In the above example of the home worth $500,000, the Equity in the home is $500,000 minus $300,000 for the Mortgage, or $200,000 (let’s assume there are no other mortgages on this home).
FORECLOSURE: The process a bank or lender undertakes to take title to a property, upon a borrower’s default on their
Mortgage or Deed of Trust.
INTERNAL RATE OF RETURN: The IRR for an investment is the discount rate for which the total present value of future cash flows equals the cost of the investment.
JUDICIAL STATE: A state in which the majority, if not all, foreclosures are processed through the courts.
LIEN PRIORITY: In most states, there is a simple rule to the order of liens or Mortgages/Deeds-of-Trust: whichever one is
recorded at the County Recorder’s office first is the senior lien; the 2nd one recorded is then 2nd in line, etc.
LOAN-TO- VALUE: The value of a specific loan relative to the equity (or value) of a home.
(LTV/ITV) For example, a property worth $500,000 has a 1st
Mortgage of $300,000. The LTV (Loan To Value) of that loan is 60%. Now if you purchase the $300,000 note at $250,000, the ITV (Investment To Value) of your purchase is at 50%.
MORTGAGE: A document that gets recorded at the recorder’s office, and which stipulates the terms that govern
what a lender can and can’t do in order to ensure repayment on their Note to a borrower. A Mortgage is a two-party agreement signed by a borrower and a lender, and it attaches the borrower’s home as the “security” that the lender can recover in case the borrower defaults.
NON-JUDICIAL STATE: A state in which the majority, if not all, foreclosures are processed outside the courts, by a Trustee.
NON-PERFORMING: A loan that does not see payment in full of principal and interest as are called LOAN for in the terms of the loan.
NOTE: A promissory note signed by a borrower that includes
the terms of the repayment of that debt, including the loan term and the number and timing of payments, the interest rate and (if the loan is an adjustable rate loan) the index and margin for that rate, prepayment penalties, etc.
REDEMPTION: In certain states, a borrower has the right to redeem their property by reinstating their Note (usually
before and after a foreclosure sale).
TAPE: A spreadsheet that a bank will use to send out their list of notes for sale that will include all details of the note such as address, loan number, borrower, property address, payment history, interest rate and other details of the specific notes available for sale.
TRUSTEE: A Trustee is a 3rd party entity that holds what’s called “bare or legal title” to a residential property in a Non-
Judicial State.
USURY: Defined as charging interest that is beyond the legal
limit set by a State. Every lender needs to be aware of federal, state and municipal or county level regulations when it comes to servicing and modifying existing loans.