Non Performing Notes | The Ultimate Guide
So, you’ve heard that non performing notes can make great investments, otherwise you wouldn’t be here, right? But achieving success in this real estate investing niche is by no means easy. This is a complex and heavily nuanced asset class, and you there is a lot to learn before diving in. In this article, you’ll find everything you need to know to get you started.
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As I have already alluded to, success in the note investing game requires knowledge, expertise, time and resources. This guide won’t make you an expert overnight, but it is a great place to start.
And please remember, I’m not offering you personalized investment advice. You should never invest more than you can afford to lose in any one investment.
What Are Non Performing Notes
In real estate, a non performing note is simply a mortgage loan on which the borrower is in default, i.e. they have stopped making payments on the loan.
Once the borrower is 30 days overdue, the note becomes sub-performing. After 90 days with no payments, the note is officially non performing.
Most lenders will try to get their borrower paying again before the 90 period is up. So by the time you see a non performing loan for sale it means the lender feels there is very little chance of the borrower making good on their payments again.
At this point the lender might sell the note to create some liquidity and avoid costly and lengthy foreclosure proceedings.
Related: Note Investing 101 – Everything you Need to Know About Note Investing
Notes and Liens
The first important distinction to make is between notes and liens.
A promissory note is a contract between borrower and lender. This defines the terms of the loan, including important information such as the loan amount, interest rate and repayment schedule.
The lien is a deed that is recorded against the title to a piece of real estate. If the borrower defaults on the terms of the note, the lender can force the sale of the real estate to settle the lien.
So for note investors, the lien is the security for your investment. That’s why clear title is so important. If your lien can’t be settled due to title issues you could lose or all of your money.
An important point to note here is that not all liens are created equal. You have 1st position liens and 2nd positions liens – also called senior and junior liens.
In most cases, 1st position loans are usually repaid first from the proceeds of a foreclosure sale. So a note with a 1st position lien offers a certain degree of capital security.
Whereas 2nd position loans are only settled if there is any money left. That means there is a much bigger risk of losing money on 2nd position notes in a foreclosure scenario.
So to recap, you have a note and a lien. But why do investors buy non performing loans if the borrower can’t pay? Well, there are lots of reasons, so let’s find out.
Related: A Guide to Lien Position and Priority for Note Investors
Why Investors Buy Non Performing Notes
There are many great reasons to invest in real estate notes. But the main motivation for investors to buy non performing notes is the fact that lenders typically sell them at a discount to the unpaid balance.
This means you can buy a loan of say, $100,000, for a much smaller sum of money. Maybe even as low as $10,000. If your discount is big enough, and you can collect at least some of the unpaid balance, then you can stand to make a really good profit.
The discount you buy a non performing note at also flows through to the underlying real estate.
When you buy a non performing loan, you become the lender, so you assume all of rights of a lender according to the terms of the note. This usually includes accelerating the loan and/or foreclosure, which ultimately means you could end up owing the real estate for the price y0u paid for the note (plus the cost of foreclosure).
Looking at that $100,000 non performing loan bought for $10,000 for example… The real estate might be worth $150,000. If you buy the note for $10,000 and foreclose the loan, the property could sell for say $100,000 at foreclosure.
Congratulations… you just earned $100,000 less costs from an initial $10,000 investment. That would be a serious home run!
Related: Performing vs Non Performing Notes – Which is the Better Investment?
Finding Non Performing Notes For Sale
This is where it can start to get tricky. I’ve seen plenty of folk get into note investing with the best of intentions, only to get ripped off buying trash notes at pumped up prices from so-called ‘note brokers’. That said, there are plenty of great sources for buying non performing loan notes, including:
- Other Note Investors (Private Sellers)
- Big Banks
- Regional and Community Banks
- Credit Unions
- Note Servicing Companies
- Hedge Funds and Private Equity Funds
- Note Brokers and Advisors
- FDIC Loan Sales
- Online Platforms
One thing to bear in mind is that the note business is very much a people business, and it’s a relatively small community.
You will need to build relationships with note sellers if you want to even stand a chance of buying non performing notes from a credible source like a bank or credit union.
And that’s also true when buying non performing loans from private sellers like hedge funds, but less so if you see a note listed for sale publicly on a note trading platform like Paperstac for example.
As I already mentioned above, there are lots of people out there who claim to be note sellers, where in fact they don’t actually own any notes to sell.
Mostly these ‘joker brokers’ are just looking for buyers to flip notes to other investors at inflated prices. You really want to try and avoid these people.
The golden rule is to stick to buying your non performing notes direct from the actual owner/lender, or from a broker that you know for sure is direct to the seller.
Another option is to partner with another note investor that is buying a tape themselves. They will probably not want to buy every loan in a tape, so you you may be able to team up and buy what they don’t want.
Buying Non Performing Notes From Banks
If you do set out to buy your non performing notes from a financial institution, there are a few things you’ll need to get sorted first.
Number one, you’ll need to have your money ready to make your purchase in advance, and you might need more than you think.
Chances are, banks and other institutional lenders aren’t going to sell you a single note, so you’re going to be buying a ‘pool’ of non performing notes. That could be more expensive than you had anticipated.
While you might not get asked to show proof of funds, reputation is everything in the note investing business.
If you make an offer and you can’t pay, you’ll burn the relationship with that seller for good. Word will likely get around the note investing community pretty quick too.
Finding genuine sellers of non performing notes might seem like a daunting task with no definitive start point, but there are some great tools out there that can help, and I’ll cover some of them in the Tools and Resources section of this guide further down.
Finding Non Performing Notes For Sale Online
If you don’t want to start building relationships with originating lenders, there are also a few online note trading platforms where you’ll find both performing and non performing mortgage notes listed for sale direct from private sellers.
Here are some of the online platforms that list non performing notes for sale:
- Paperstac – A great online platform where investors can list any notes they have for sale. You’ll definitely find some non performing loans here.
- Notes Direct – Another online note trading platform that offers all sorts of non performing notes for sale.
- Loan MLS – There are few options on this platform. you can buy non performing notes, post wanted ads, and even originate new loans.
- Watermark Exchange – Banks and other lenders list their non performing notes on this site for retail investors.
- Note Trader Exchange – You can bid for notes on this site, and you’ll certainly find non performing loans there.
- CREXI – Focussing mainly on commercial real estate sales, this site also lists loans secured against commercial property, some of which are either sub performing or non performing
If you do find a non performing loan to buy privately, make sure you do your due diligence on the seller as well as the note. Remember, this marketplace is full of sharks, chancers and wannabes, and you lock in your profits by buying at the right price!
Related: My Ultimate List of Sources With Mortgage Notes for Sale
The Note Buying Process
If you’re buying non performing loans from a bank, credit union or similar, the purchase process is going to look a like this:
- The note seller offers you a tape of non performing loans with some basic information about the borrower, property and note.
- You do your initial due diligence based on this information, and make your initial bid based on what you are prepared to pay for that loan.
- If your bid is accepted, the assets are tied up and you get access to more detailed information to do your secondary due diligence.
- You can then stick with your initial bid, or fade (reduce) your offer based on the results of your secondary DD.
- If you are successful, you wire funds to escrow to complete your purchase.
Unlike banks, private sellers are more flexible, maybe give you more time, and you may get access to the collateral file and other due diligence materials ahead of making your offer.
So, let’s assume you’ve done the hard work, built a good relationship with a genuine note seller, and you’ve been offered a non performing loan, or tape of non performing loans to bid on. This is where the work really begins….
Doing Your Due Diligence
Due diligence is a huge part of investing in real estate notes. Your ability to buy non performing notes for a good price (that you can actually work out for a profit) will be the cornerstone of your success or failure.
In order to ascertain the price you should pay – and the quality of the notes and/or real estate – you will need to create and perform a solid due diligence process.
This can be broken broken down into two parts; initial due diligence, and secondary due diligence.
Initial Due Diligence and Bid
When you get hands on a tape of non performing loans from a seller, it will include various data points about the notes, borrowers, and real estate. This will most likely include:
- Some information about the borrower
- The property address & occupancy status
- The unpaid balance of the loan (UPB)
- The date the last payment was made
- The date the loan was originated
You might get more or less information than this depending on the seller, but for the most part you’ll be using this information to make a decision about how much money you’re prepared to pay (your bid).
This is essentially a process of elimination based on what type of notes and/or real estate you do, or do not want to buy. What you are doing is creating a shortlist of notes that fit your buying criteria. Here are some good rule-of -thumb basics to get you started:
- If you are averse to investing in any particular State, get rid of those notes first.
- If you have any limiting parameters in terms of property location (City or neighbourhood), for example crime rates, occupancy levels or population statistics, eliminate those too.
- Also discard any notes where the real estate itself doesn’t meet your criteria. That might be older houses, or small houses for example.
- Next, disregard any notes that don’t fit your investing objectives. For example, you might not want to tackle a note with a really bad payment history, or relatively large unpaid balance.
Once you’ve gone through this process you’ll be left with a pool of non performing notes that you actually want to own. Now you can deliver your bid for those notes based on what you think they are worth.
Secondary Due Diligence
If your initial bid is accepted for any of the notes, you will be presented with more information by the seller. Your job now is to work through this information and decide if you want to stick to your initial bid, or fade (reduce) your offer.
There is a lot do here, so I strongly suggest you utilize professionals to make the job easier. I especially recommend finding a good attorney and a title review company. I’ll list some useful tools and contacts in the Tools and Resources section of this guide. For now, let’s look at the 4 key areas of analysis. They are:
- The physical real estate
- The title
- The note collateral
- The legals
So let’s dive right in…
The Real Estate
Remember, you aren’t going to be able to do a full property inspection when you’re buying a note like you probably would if you were buying the house. The best you’ll get is a drive-by… maybe some internal photos at best. So make sure you account for possible repair costs when you make your bid. Area Analysis If you’re buying a note in an area you don’t know, you will want understand the dynamics of the local real estate market. Some key areas to look at here are:
- Historical and current population growth rates (local area)
- Historical and current population growth rates (wider area/nearest commutable metro area)
- Historical and current property vacancy rates
For me, this is the absolute bare minimum of information I want to know about the area. This helps me to form an opinion about whether I want to own a property there or not. That will then influence whether or not I’ll bid on a note.
Of course, you can always dig a little deeper. Here are some further useful questions you can ask about the area:
- How close is the property to transport links?
- Is employment in the area growing?
- Are there big, stable local employers?
- Is it more a rental market, or are house owner occupied?
- What are the crime stats?
- Is the property in a flood zone?
- What do properties of the target type rent for?
- Are local schools any good?
There are a ton of online resources you can use to find answers to all of these questions pretty quickly (see Tools and Resources later on in this guide). I also find it useful to speak to local Real Estate Agents and other RE or Note Investors that are active in the area.You can find plenty of each through local REIA groups, both face to face and through social media.
Physical Property Analysis
There is some basic information you want to know about the actual collateral property for the non preforming note you are assessing. Remember, you may end up owning the real estate, either to sell or to rent and hold. Whatever the most appropriate strategy for the note at hand, here are the basics you’ll want to know:
- Area (sq. ft.)
- Number of bedrooms
- Number of bathrooms
- Year built
- Lot size
- What type of property (Single family, multi family, commercial etc.)
- House type (e.g. ranch, rambler, colonial, split-level)
- How many levels
While this might seem like a lot of information, you’ll find most of it readily available in a Brokers Price Opinion. And I HIGHLY recommend you get one for every non performing note you buy.
A BPO is also a useful tool in private lending I provide my investors with a BPO whenever they make an investment through our Private Lending Program.
Not only does a BPO give you the data points you need for the subject property, you’ll also see comparable local listings, including recently completed sales.
What you get with a BPO is a fairly accurate professional opinion from a knowledgeable local Realtor as to the value of the property on the open market. That is priceless, and removes a ton of the guesswork for my lenders.
Now in my case, our BPOs are always pretty accurate because they’re based on a full physical inspection of the property we are buying. When you are buying a non performing loan, however, that is not usually the case.
Neither you nor the Realtor producing the BPO will have been able to do an internal inspection, so your note buying BPO will be based on the assumption that the property is in good, marketable condition.
In reality, you may in fact have to spend some serious rehab dollars to get the house into sellable shape, so factor that in to your ROI calculations.
Calculating Estimated Rehab Costs
I have rehabbed over 100 houses in my markets, So I have a pretty good handle on what a renovation is likely to cost. One thing I can tell you quite honestly is that something unexpected always turns up and causes you a problem (and costs you money) during a rehab.
Ideally, you want an opinion from a local contractor that has at least driven by the home. But that may not always be possible, so at worst you can use this very broad rule of thumb to make an estimate on repairs:
- Light -> $10/square foot
- Medium -> $15/square foot
- Heavy -> $20/square foot
So, if you had a 1,000 sq. ft. property in reasonable condition, a light rehab might cost you $10,000. That said, it’s a good idea to at least have a general conversation about costs with a local contractor. Labour and material costs can vary significantly in different parts of the country, and you don’t want to get caught up in a rehab that cost way more than you factored in your bid.
Taxes, Title and Liens
This next part of your due diligence process is extremely important. Title issues can really screw your non performing note investing efforts – I’ve seen it many times! The last thing you want is a note you cannot foreclose, real estate you cannot take clear title to, or title with a bunch of tax liens or HOA liens that will eat into (or eliminate entirely) your profits.
The first thing you want to do is order an Owner & Encumbrance (O&E) Report from a title search company. These cost about $10o per property, and they are worth every penny! Each report will typically tell you:
- Vesting information (who owns what)
- Mortgage and assignments
- Federal, state and municipal liens
- HOA lien
- Civil judgements
- Foreclosure proceedings
- Tax delinquency status
- Property information (e.g. property address, parcel ID, legal description)
- Current owner deed
Having all of this information in one place will save you so much time! Here’s what to do once you have your Owner & Encumbrance Report…
Check the O&E report for delinquent property taxes. Also make sure to call the County Tax Office and ask if any tax liens have been sold. If they have, you’ll have to settle them.
Pro Tip: Ask the County who last paid taxes. If it was the lender, that doesn’t look good on the Borrower’s current situation. That might influence the likely outcome and therefore your game plan for that note. Also ask for the mailing address of the the last person to pay the property taxes. That will help you understand if the property is owner occupied or not. That might save you a LOT of time and effort later on.
Next, check to position of the lien associated with your note. A 1st position lien will always be top of the report. If it isn’t, you have a problem.
Pro Tip 1: Make sure to check out the recording dates of any other liens or judgements in order to ascertain their priority (first recorded, first settled). In any case, you’ll have to settle all liens if your exit strategy is to sell the house, so you need to factor that into your bid.
Pro Tip 2: Check if the property is located in a Superior Lien State. If it is, HOA and COA liens will automatically be placed in 1st position, and the HOA can force a foreclosure even if you hold a 1st position mortgage. Utilities Liens Liens from utilities, sewer and water companies should show on your report, but it is definitely worth double checking with the relevant companies that accounts are up to date. I know that in one of my markets you have to bring utilities accounts current before you take over the property.
Pro Tip: Check with utility companies if any of the utilities are shut off. That is a pretty good indicator that the property is vacant. If your main aim is to get notes reperforming, you’ll probably want to avoid vacant houses.
This is absolutely worth checking out. Some States have huge fines for code violations like overgrown yards and items of obvious disrepair. Again, you could end up with a big chunk of money coming out of foreclosure proceedings if you’re not careful.
Collateral File Review
You’ll hear a lot about the collateral file when you’re learning bout investing in non performing notes. This is the packet of documentation contain all of the information pertaining to the note and mortgage. You’ll get a soft copy of the file after your initial bid is accepted, then the note seller will send you hard copies after you close on a successful bid.
Here’s what your collateral file will most likely include:
- Mortgage / Deed of Trust
- Riders (e.g. Adjustable Rate Rider)
- Note and Note Addendums
- Title Policy
- Final HUD-1
- Potential Loan Modification Agreements
- Allonges to Note
- Assignments of Mortgage / Deed of Trust
- Loan Servicing Notes
- Borrower Credit Reports
- Other Pertinent Documentation (e.g. Error and Omissions / Compliance Agreement, Borrower’s Driver’s License)
Now there is a heck of a lot to do here, so I strongly suggest you outsource your collateral review to a professional. Either find a good attorney in the State your real estate is located in, or use a professional collateral review company. I’ll name some good options for you later.
Pro Tip: Make sure all notarized documents have been stamped by a notary with a valid licence. If their licence was expired, that could cause you serious problems down the line.
If you’re determined to review the collateral file yourself, here are some pointers:
Mortgage/Deed of Trust Checklist
Every deed is different, so even if you outsource this part of your due diligence process, you’ll still want to be familiar with what should be included. Here’s a list of what you should verify:
- Due on Sale Clause
- Language on Lender Recourse Provisions
- Signed by Borrower
- Notarized by a Notary Public in Good Standing
- Language Requiring Insurance on Property
- Language Requiring Borrower to Pay Taxes Accrued and Due
- Late Charge Provisions
- Foreclosure Procedures
- Accurate Legal Description with Property Lot and Block
Pro Tip: make sure to check that the deed is fee simple rather than fee simple conditional or leasehold. Anything other than fee simple means you probably won’t own the property outright.
Promissory Note Checklist
As I have already mentioned, the promissory note is a contract between borrower and lender. You will want to verify some of the key information contained in the note, including:
- Total amount of the loan
- Monthly payment
- Origination date
- Maturity date
- Loan term (length of the loan)
- Interest rate before default
- Interest rate after default)
- Borrower’s address
- Lender’s address
- How payments will be applied?
- Late payment provisions
- Usury Savings Clause
The note will also contain waiver provisions. A waiver is a legally binding clause in which both parties to a contract voluntarily agree to forfeit a claim without liability on the other party. Your note could and should include the following waiver clauses:
- Notice of intent to accelerate
- Notice of acceleration
- Maturity protest
- Notice of protest
- Foreclosure notices that can be waived by law
- Anti-deficiency statutes
Pro Tip: When you’re reviewing a non performing note, keep an eye out for estoppel certificates and loan modification agreements. Estoppel certs are used to ensure neither party can contradict the agreed terms later on, For example defining the interest rate or unpaid balance. If there existing are loan modifications it will absolutely affect your bid price.
Loan Servicing Reports
Ask for a Borrower Payment History Report and a Payoff Report from the note seller’s loan servicing company. These reports could contain vital information that will affect your bid price. They will also contain information that will help you form an idea the most appropriate (or likely) workout plan for the note. The Borrower Payment History Report will tell you:
- The payment history of the borrower
- The current Unpaid Principal Balance (UPB)
- Current interest rate
- Maturity date
The Payoff Report will tell you if the borrower has made any large payments against the loan, effectively reducing the unpaid balance.
Pro Tip: Make sure the Payoff Report is very recent (like, a couple of days old at most). If the borrower has recently made large payments, you might be due these under the terms of the Loan Sales Agreement.
Borrowers Credit Report
The collateral file you get with a non performing note will usually have the borrower’s credit file from when the loan was originated. Sometimes you will even get a new credit report.
You’ll get a good idea from this report as to the quality of your borrower. If they have a ton of debt and they have been missing payments on the note, they could be heading to bankruptcy. They may also be less likely to keep up the terms of any loan modifications you make to get the note reperforming.
Pro Tip: Since 2018, most tax liens and civil judgements no longer appear in a borrower’s credit report. If you want a more comprehensive picture of the borrower’s credit, a LexisNexis Riskview Liens and Judgement Report gives you all the borrower’s liens and judgements.
Assignments and Allonges
An assignment conveys a mortgage or deed of trust from one lender to another when a mortgage is sold. Assignments are recorded along with the mortgage or deed of trust in the County records. An allonge conveys a promissory note between lenders. Allonges are addendums to the note, and they are not recorded in the County records.
Having a clear chain of assignment and a clear chain of allonges is essential. You want to see a clear trail of ownership from the original loan originator through the current lender. Any break in the chain could cause you big problems.
Pro Tip: If you cannot find the assignments of your mortgage, it might be held in Mortgage Electronic Registration System (MERS). If the mortgage is recorded in MERS it will have an 18-digit number – called an MERS Identification Number (MINS) – at the top of the deed paperwork.
For this part of your non performing loan due diligence process, you will require the input of an attorney, possibly 2 attorneys – one specializing in foreclosures, and another in bankruptcy. Pending and In-Progress Foreclosures The O&E report will contain details of any pending or in-progress foreclosures. Look out for the term Lis Pendens – which means suit pending – and also Notice of Substitute Trustee, which means that a foreclosure has already started. If that’s the case, you should pass the file to your foreclosure attorney who can check on the status of the case.
State laws vary, but in many cases you may be able to step in a take over the foreclosure proceedings as the new lender. Again, consultation with an appropriate attorney is a must. this is great of your ultimate aim is to acquire the real estate. Make sure to check whether the real estate is located in a non-judicial or judicial foreclosure State.
Judicial foreclosures are time consuming and expensive, so you’ll need to factor that in to your return on investment calculator. Also, non judicial foreclosure States have a redemption period after the foreclosure is completed. This means the home owner has a period of time in which they can reclaim their home. This varies depending on a number of factors, so ask your foreclosure attorney to advise you.
Pro Tip 1: Check the Loan Sales Agreement and make sure you are not subject to assumable legal fees. This could leave you on the hook for thousands of dollars in fees already stacked up, so you will need to fade your bid accordingly.
Dealing With Bankruptcies
If the borrower has filed for bankruptcy, you’ll most definitely want the help of a specialist attorney. Bankruptcies can be very complex and nuanced, so making sure you know what you’re getting into is a prerequisite to buying a non performing loan.
Despite how it might sound to the uninitiated, bankruptcy is not always a bad thing for the non performing note investor. In fact, some note investors actually prefer notes where the borrower is in bankruptcy. That’s because bankruptcy doesn’t cancel the debt, it just means the borrower does not have to pay it during the bankruptcy process.
You can also even receive payments a note during a bankruptcy. For example, during a Chapter 13 bankruptcy filing, a court appointed Trustee continues to make payments to the creditors in line with a court-prescribed bankruptcy payment plan.
While unsecured creditors like credit card companies can get wiped out entirely in a bankruptcy, mortgages notes are backed by the physical real estate. If you have a 1st position lien (and title is clean), then you’re going to get something back when the property is sold. If you’ve paid the right price for the note based on your due diligence, then you can stand to make a handsome profit.
Pro Tip: Use the Public Access to Court Electronic Records (PACER) system to look up bankruptcy court filings. So there you have it, my initial and secondary due diligence process for investing in non performing notes.
Obviously there’s rather a lot to take in here, and by no means is this guide definitive. But now at least you know enough to get started, so let’s go ahead and take a look at some useful tools and resources that will help you along the way.
Some Useful Tools and Resources
As you can clearly see, when buying non performing real estate notes, your due diligence process defines the notes you do or do not buy, as well as the price you pay. So it’s safe to say it’s important, right? Fortunately, there are are useful tools and resources that can help you along the way. Here are some of them that I personally use.
Physical Real Estate
The gold standard for real estate assessment and valuation is a full appraisal, but as we have already ascertained, you’re not going to get one of those when you’re buying non performing mortgage notes. The next best thing is a Brokers Price Opinion or Desktop Appraisal. That’s what I use, and that’s what all of my private lenders refer to before originating a new loan.
Basic Property Info and Values
During the initial stage of your due diligence – when you’re assessing non performing notes based on basic information from the tape – there are some free online tools you can use to collect basic property data points, and get a rough approximation of real estate values in the area.
Realtor.com -Realtor carries listings nationwide. You will find basic property data such as the number of bedrooms, bathrooms and square footage. You might also find previous listings and sold prices/dates for that property.
The websites listed above will certainly give you some useful area statistics as well as basic property data and approximate valuations. They also contain some useful information information about the area such as local school districts and ratings, and crime statistics.
City Data Points and Area Analysis
As well as using the websites above to pull things like local area crime stats and local school ratings, there are some great online tools to help you compile more comprehensive city data points and analyze the local area and nearby metro areas.
USA.com – This is a great website that gives you easy access to a bunch of useful City data points such as population growth, demographics, household income, as well as housing data such as occupancy data and home ownership ratios. you’ll also find information on crime statistics and education.
Census.gov – This is another great source of information about an area. You’ll find information on housing, demographics, education, health, the economy, household income,
Title Due Diligence
When it comes to potential title issues during phase two of your note investing due diligence process, you are way better outsourcing than trying to do all of this yourself. Here are a couple of companies that can help.
ProTitleUSA.com – These guys are great for reviewing title and identifying potentially deal-killing issues. They will carry out a comprehensive collateral file review, as well as offering a range of additional products, including the essential Owner and Encumbrance Report, bankruptcy reports and much more.
Expert Mortgage Assistance – Expert Mortgage Assistance offers a title examination service, as well as a ton of other reports and services for lenders. I have not personally used these guys, but according to their website they conduct a review of the title report including any legal claims, lawsuits, taxes, judgments, and liens. They also conduct a quality review to ensure the right sequence of file numbers, presence of all pages, and quality of all images.
So, I’m clearly an advocate for outsourcing your title review. This will save you time, effort, and potentially costly mistakes. I’m also an advocate for hiring out the review of your collateral file, and there are people that can help you with that, too.
Collateral File Review
If you can find one, a good attorney will be able to help you review the collateral file for a non performing note purchase. But if they are not a specialist in this area, or have not provided this specific service to note investors previously, you will need to provide them with a very clear and defined checklist of items that you want reviewing.
Here are details of some specialist companies that offer collateral file review for note investors.
Nationwide Title Clearing – NTC offer a collateral file review and remediation service. this includes; validating And maintaining accurate data, restoring defective collateral documents, identify servicing data discrepancies, and recovering or replacing missing collateral file documents.
Mortgage MetaSource – These guys offer a Whole Loan Purchase Review Service. I have not used them, but according to their website, this service promises to deliver customizable criteria for determining risk and clarity on risk exposure for investors, and rapidly identify and correct defects.
Richmond Monroe – RM offer a complete collateral file review designed for note investors. They also offer bolt=-on services to correct any defects that are found during the review process.
Legal Due Diligence
When it comes to legal matters, there is absolutely no substitute for hiring a good specialist attorney. There are, however, some useful resources you can refer to to get an initial handle on things.
PACER – You can access case files and documents relating to legal proceedings in federal appellate, district, and bankruptcy courts from the Public Access to Court Electronic Records (PACER). This is useful for looking up foreclosure and bankruptcies.
So, there you have it, some useful tool and resources that will help you to streamline and expedite your due diligence process when buying non performing loans. Next, we’re going to look at some of the non performing note investing strategies you will use to create a profitable exit strategy once you have acquired a note.
Workouts and Exit Strategies
Once you’re the proud owner of a non performing note, or maybe even a pool of notes, you have to figure out what to do next. First off, you may have some legal obligations around contacting and notifying you borrowers. But I won’t go into all that here. Right now we’re going to focus on the 5 main workouts you can deploy.
Workouts Through The Note
If you are not specifically buying non performing loans in order to subsequently own the real estate, there may be options for you to create a profitable exit strategy or buy and hold investment without ever taking ownership of the bricks and mortar.
Flipping Non Performing Notes
Sometimes you’ll find yourself owning a non performing loan that doesn’t really fit your buying criteria. You may have had to purchase a loan alongside other notes you really wanted to own, or the note, real estate or borrower might not be what you thought it was. You might just have bought a note at such a good price that you prefer to sell it on for a quick profit.
This being the case, you can try flipping the note to another investor who is better-positioned to take it over, or is prepared to pay a better price. You can list these notes for sale on the websites I quoted earlier in this guide such as Paperstac. I have seen plenty of investors do this with varying degrees of success.
Non Performing Loan Modifications
You can add a significant amount of value to a non performing note by working with the borrower to get them paying again. I know of many investors who only buy notes where they think this is possible.
For example, you might buy a $150,000 non performing loan. If the house is worth say $100,000, the homeowner might agree to a new loan and terms, of say, $90,000 at 6% interest. So, you modify the loan balance to $90,000 and the borrower starts paying again.
If you are successful in your loan modification endeavours, there are a number of things you can now do:
- Keep the note for the monthly income (you’re getting 6% on $90,000 after investing $50,000)
- Sell the note as reperforming for say, $80,000
- Sell part of the note to another investor (a partial)
- Borrow $50,000 against the note to buy another note and repeat
- Have the borrower refinance after 3 months on the Home Affordable Foreclosure Alternatives (HAFA) program and get a payoff
Now this all sounds very simple, right? Not so fast! Loan modifications are by no means easy, or even possible a lot of the time. You are dealing with real people with real problems, and many borrowers simply cannot or will not agree to new terms no matter how attractive you make it.
Even just getting hold of the borrower to open a line of communication van be difficult. Remember, these are loans that have been considered unrecoverable, so the previous lender has probably exhausted many of the options before selling the note as non performing.
I used these note workouts in 2010 when I was part of a team that acquired a pool of non performing loans from a bank. Some of those loans were immediately flipped to other investors, while others were modified and resold later.
Workouts Through the Real Estate
If you cannot (or do not want to) workout your non performing note investment through the note, you can do so (or attempt to do so) through the real estate. But that doesn’t always mean you have to foreclose, or even take ownership of the property. Let me explain.
Taking a Deed in Lieu
Taking a Deed in Lieu can work out to be much easier and cheaper than going through an expensive and time consuming foreclosure process. Essentially, the borrower signs over title of the real estate to you – the new lender – in exchange for forgiveness of the debt. Most banks and credit unions will try to get a Deed in Lieu before selling the note as non performing.
Pro Tip: In my experience, it is best to have the loan servicing company work out the finer details to make sure you get clear title, especially if there are other liens against the property.
Arranging a Short Sale
If taking a deed in lieu is not an option, the next step might be to arrange a short sale of the property. If you are the only lien, then you will have full control of the short sale process. If there are other liens then you will have to negotiate with those other lender/creditors.
If you buy the non performing loan at the right price, there should be ample room in the sale price to cover the cost of selling the real estate, including agents fees and closing costs, as well as your profits. If there are other liens you will have to factor in the cost of settling those too.
Foreclosing on a Non Performing Loan
Foreclosing on a non performing note is the backstop exit strategy for note investors. If you have attempted a loan modification, short sale and/or deed in lieu and have got nowhere, then a foreclosure could be the only option you have left.
Foreclosing can be expensive and time consuming, so make sure you factor both the dollar cost and time cost of foreclosure when you make your bid. Personally, I think you should work out your initial bid based on the assumption that you will foreclose. If you are then able to do something else it’s a happy bonus, but at least you will have your costs figured out ahead of time.
Once the foreclosure is complete, you will own the real estate outright. So then you can do whatever is best suited to that property and/or your investing objectives. Maybe you want to rehab the home and sell it. Maybe you want to rent it out. Perhaps your may want to refinance it.
Pro Tip: Make sure to research the cost of foreclosure in the State other real estate is located in before you bid. In some States the process can take as little as 45 days, in others it can take years and costs many thousands of dollars.
So that pretty much covers (in very broad strokes) what you will aim to do with most of your non performing note investments. In some cases, if you want to own the real estate – you might go right to foreclosure. In other cases you might spend more time and effort trying to get the note to reperform do you can keep it long term.
At the end of the day, you’ll start with the most profitable and/or goal-appropriate strategy for each specific note. If that fails, you’ll move on to the next, and ultimately end up foreclosing if everything else fails. but what kind of money can you make? is investing in non performing note profitable? let’s take a minute to find out.
Related: How to Invest in Real Estate Notes – 7 Mortgage Note Investing Strategies
This section is going to be pretty short. While the return on investment from performing notes is pretty easy to define, the return on your investment in non performing loans is entirely subjective. There are so many variables that can impact the outcome on any particular note, it really is impossible to quantify. The best I can do is speak to my own experience.
When I was involved in the purchase of a large pool of non performing notes in 2010, they were acquired so cheap that many of them turned 400% or more returns. That was based largely on loans we were able to modify. Those that were flipped we doubled our money on quite easily. Those that were foreclosed were also very profitable, but with a very wide range.
But that was back in 2010. We were coming out of the great recession, and banks were falling over themselves to rid their balance sheets of bad debt. With such a low purchase price, it was easy to succeed even if we didn’t do a great job!
While some pundits and commentators are suggesting that we are facing a similar situation with non performing mortgage debt today in the US due to Covid, I tend to disagree. Of course, I do see that there will be more defaults and foreclosures – that’s already happening – but the fundamental cause of the issue is way different to 2008. I just don’t see the same level of panic in the banking community.
Besides, unless you have very deep pockets like some of these heavy hedge funds, chances are you’re not going to get the first bite of the cherry when it comes to finding non performing loans for sale at 10 cents on the dollar.
With all that said, I think it is more than feasible for smaller investors to aim at a total overall return on investment of 20% p.a. If you look at most note investment funds, they offer a return for their passive investors of around 10% p.a., So somewhere between those two markers would be a reasonable target for most folk.
The questions is… are you prepared to do all this extra work, and take on all this extra risk, for a potential 20% p.a. return, when you can just invest passively in a note fund, or a private lending program like ours for a 10% p.a. return with none of the hassles and way less risk? that’s your call!
The key thing to remember is that the return on your investment is your compensation for the amount of risk you took. Ergo, a higher return means your taking more risk with your money. At the end of the day that old adage stands true… never invest an amount of money in any one single investment that you cannot afford to lose.
As it happens, I’m going to talk about risk right now in our penultimate section below.
Related: See How Our Investors Are Collecting 10%+ p.a. With Passive Income Performing Notes
Are Non Performing Notes Risky?
The short answer is, yes… investing in non performing notes can be a risky business. And don’t let anyone tell you different. There are many moving parts to every single investment, so there is plenty that can go wrong… and it often does. I have seen plenty of people set out with the best of intentions lose good money by making ill-informed decisions, or getting blindsided by some obscure title issue, big real estate repair, or difficult borrower.
While there is no set formula to speak of, I tend to separate note investing risk into four main categories:
- Credit risk – risk associated with your borrower
- Physical real estate risk – risk associated with the physical building
- Title issues – risk associated with the title
- Market risk – risk associated with the real estate market
It is impossible to plan for all eventualities when you’re buying non performing notes. You can bet there will always be something unaccounted for that you will have to deal with.
The best advice I can give you is the prepare yourself for the fact that not every non performing loan you invest in will work out how you hoped. You will have to take the rough with the smooth, probably suffer some losses along the way, and especially expect for things to take way longer than you thought they would.
With that in mind, and with the knowledge you have gained from this guide behind you, you’re hopefully going into things with your eyes open, and with realistic expectations.
I hope you found some value in these 8,000 or so words. like I said right at the beginning, this guide won’t make you a real estate note investing expert, but it is a good start. Remember… keep investing in your own education, the more you know, the better your investing decisions will be.
Related: Earn up to 12% p.a. with Immediate Cashflow in our Private Lending Program
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