Well first, we need to ask what a "Note" is in the Real Estate world.
In the United States, a mortgage note (also known as a real estate lien note, borrower's note) is a promissory note secured by a specified mortgage loan. It is a written promise (an obligation) to repay a specified sum of money plus interest at a specified rate and length of time to fulfill the promise. While the mortgage deed or contract itself hypothecates or imposes a lien on the title to real property as security for a loan, the mortgage note states the amount of debt and the rate of interest, and obligates the borrower, who signs the note, personally responsible for repayment. In foreclosure proceedings in certain jurisdictions, borrowers may require the foreclosing party to produce the note as evidence that they are the true owners of the debt.
A Note or Mortgage becomes a Non-Performing Note (NPN) when the borrower has not made his or her scheduled payments for at least 90 days. The loan is then classified as in default. Once the Note enters into a default statues, the Note holder is automatically granted full legal rights and legal remedies' to redeem their money invested. If the borrower doesn't catch up on their payments, then the lien-holder has legal recourse to start foreclosure proceedings as a legal remedy to satisfy the debt owed based on the terms the borrower agreed to in exchange for the money to actually buy the property. The Lien Holder is in the number #1 position as to the of the underlying collateral and its future disposition.
Due to Wall Street and Banking Regulations, entities are forced to sell off certain non-Performing Assets in order to preserve the lending institutions finance stability. Odd as it may seem to be, selling-off bad assets at bargain basement prices can actually make a Wall Street Bank solvent once again. These NPN are traded and purchased by Banks, Wall Street hedge Funds and other Financial entities AND investors, like us!
After all, the homeowner isn't paying, so it's a dead-end, right? No, this is where the opportunity for large, above average returns is made. Because buying a mortgage note that isn't paying allows us to step into the shoes of the bank and find a more creative solution than a commercialized formal institution ever could. Sometime this means, the investor, can modify their current loan and get them repaying, and sometimes this can be relieving them of their debt by getting a Deed In Lieu of foreclosure or through the foreclosure process itself. But the key to eliminating risk, is the proper Due Diligence. Due Diligence is your safeguard to making a mistake.
Eliminating risk. Anything is risky, especially if you don't know what you are doing. Palomar Note Buyers uses a Specific Protocol in evaluating distressed assets. We do this so we can screen-in the highest yielding, quality paper backed by a Solid. desirable asset. The paper is only worth what the value of the securitize asset worth. Again we are note buying houses but the paper that gives us the full legal power and authority to use all legal measures to preserve out Return of Investing. That's right the Return of Investment is the basis for a Return On Investment. You need both for us to buy the correct asset.
Banks sell non-performing loans for any number of reasons. Here are some of the reasons I've seen.
I should point out that banks aren't the only sellers of non-performing notes (in fact you can find list of the different places where you can buy non-performing notes here) but banks and credit unions are where most non-performing notes originate. Almost anywhere else that you buy them means one or more middlemen and therefore higher pricing.
1. Banks sell notes to avoid unknown liabilities
Sometimes a lender will have a non-performing note on an asset, like a gas station or an old factory where they don't want to foreclose due to the possibility of the existence of environmental contamination of the land.
Once a bank gets into the "chain of title" there's the possibility that they open themselves up as a target for future liabilities, litigation, etc. A smart (and litigious) person goes after "the money". Obviously that's the bank.
If you can think of reasons that the bank might not want to get into the chain of title then so can they.
2. Banks want to avoid excessive legal costs and long foreclosure processes
Different municipalities have different laws regarding foreclosures. If a bank has a pool of non-performing loans in an area where they know that a lot of long, drawn out foreclosures will be required then it can be more advantageous to sell the note.
3. Banks don't always have the same flexibility and workout options as private investors
Banks don't always have the same kind of flexibility that you and I would have in terms of how we would approach a loan workout because they're regulated.
Remember, banks are highly regulated, that means that "the box" within which they must work to "rehab" or restructure a loan is not as malleable as that of a private investor or fund.
4. Selling non-performing loans is fast
A bank can sell and close on a non-performing loan sale in under a month. That means they're refilling their coffers and eliminating a ton of man-hours, legal fees, and months of effort. Consider what's involved in foreclosing on a property, probably "booking it in" (meaning that they buy the note back at auction), then listing it and selling it.
Consider all these expenses banks face if they don't sell the non-performing note:
- Legal fees for notices
- Auction fees
- Property preservation costs
- Municipal compliance costs
- Realtor fees
- Market price risks
The list goes on. Once a bank adds up all the costs and time that it can take to deal with foreclosing on a lot of non-performing loans you can see pretty quickly what the advantages are to simply selling notes.
Finding the value of non-performing loans is one of the most often ask questions we get and to be honest the answer isn't as easy one.
The difficulty in finding the value of non-performing notes is 3-fold.
- The note
- The collateral
- The borrower
First you need to understand the nature of the note.
- What is the UPB or unpaid principal balance?
- What is the interest rate?
- What's the default interest?
- What covenants are there?
- What other liens are there and in what priority?
Second you need to consider the collateral
- What do we know about the value of the property (assuming this is a non-performing real estate loan)?
- Where is it located?
- What is happening in the local market?
Third, what do we know about the borrower?
- If there's recourse (in the case of a commercial note) if the borrower someone you can collect from?
- Is the property used for the borrower's personal business or residence?
- Are there mitigating circumstances for the borrower that lead you to believe you can get it quickly re-performing?
As you can see the number of factors in finding the value of a non-performing loan get complex quickly.
Additional questions that you need to ask about a non-performing loan if you want to assess its value have more to do with you and your investor's needs.
- What strategy are you using?
- Are you aiming to own the collateral?
- Will you try to get the loan re-performing or do you aim to own the real estate?
Answers to these questions will drive the answer to "what is the value of this non-performing loan... TO ME".
Non-performing Note investing is more secure, more unsurprising, and yields considerably higher profits than any other investment vehicle that I know. NPN's put the Note-holder in the number one position. You're ahead of speculators, you're ahead of the last in line fix and flippers, you're ahead of the "We buy Ugly Houses' guys. You're ahead of all of your Real Estate investing competition. Investments are secured by a 1st lien on the property, affording you numerous ways to exit safety and profitably, with returns on your capital investment typically ranging from 12-15% or higher.
Brilliant investors are putting their capital into the paper to control, acquire and flip real estate. As a private lender owning mortgage notes (you are the bank), you can enjoy high, stable returns by investing in notes that are backed by the 'Right' property asset. You can get excellent returns without the hassles of managing any property.
Some of these asset are perfect for cash flow income. Instead of owning a home and dealing with tenants. Once the Non-performing Note is turned into a Re-performing Note you can get monthly income without being the landlord. As you are now the 'bank' the homeowner makes payments to you, just as if it was a landlord/tenant relationship. But in this case the tenant is responsible for fixing their own leaky roof, toilet, mowing the lawn and paying the property taxes, not you. For this privilege the homeowner pays you a monthly income for the next 20 years. And all you did was buy the right Paper Asset, at the right price (usually for 25-50% of the homes current value). That's right we buy these asset for roughly 50% of the underlining asset current market value.
Excited? I was too when I started looking at this business.
The best and most reliable way to buy notes direct from banks is to begin with the decision makers at your local, community and regional banks and credit unions.
Buying notes from banks is essentially a B2B sale. You are in business and they are in business. They have a problem and you have a solution. You need to find the right banks and then find decision makers.
Here’s what the process looks like in broad strokes-
Buying Notes Directly from Banks-The Short Version
- Find local, community, and regional banks that have the types or notes you want to buy. Banks file reports each quarter that give us surprisingly deep insight into which banks are selling notes and which aren’t. We use these reports to find the real sellers and then we use a collection of other resources to find decision makers.
- Call as high up in the bank as possible and have the decision makers direct you to the people who are responsible for selling notes. This person’s title or the department’s name will vary from bank to bank depending on the size and to some degree the locale. We have a complete list of titles in the Academy. The smaller the bank and bigger the credit (credit = bank-speak for note) the higher up the chain the decision will be made.
- You need to gain an understanding of their note selling process. Some banks will have a dedicated trading desk. Some banks will have the “line” (loan officers) handle their own workouts. Some banks will have direct involvement from top officers. You don’t know how any one particular bank handles their note sales and workouts until you call, speak to a decision maker, and ask.