Turning a Non-Performing Note into a Rental Property and a Good Deed

by | BiggerPockets.com

non-performing notes and rental propertiesThe mortgage meltdown has put many hard-working good people in tough situations where foreclosure is their only option. Even though this market has created the best buying opportunities in decades, there are more people just like a homeowner I recently ran into.  I thought this case study might inspire you as you purchase mortgage notes. Let me explain…

I was recently offered a non-performing 1st mortgage note (there was no 2nd) for $20,000 in a neighborhood where the average comparable sale is currently $50,000. The underlying asset, a nice 3 bedroom brick house in a cul-de-sac is in great condition.  The homeowner is still in the house but was moving out because they knew they could not afford the mortgage payments anymore. I also found out, the homeowner fell behind in their payments due to an adjustable rate mortgage. This is a very important bit of additional information. The homeowner was able to stay current in their mortgage payments when the payments were approx. $700 a month but as the payment kept adjusting they fell behind, no longer able to afford the payment that had ballooned to $975 a month. I had to interview the note holder several times to get this additional piece of information but as you will see, it becomes quite valuable..

The most obvious and common approach for banks would be to foreclose on the homeowner and take back the property. Yet, I decided to take a different approach and you can too. Having done proper due diligence on the situation prior to purchasing the note I wanted to talk directly with the homeowner before I went the foreclosure route. I arranged to meet the homeowner at the house.  I let them know over the phone I was not looking to evict them or give them an ultimatum, I just wanted to talk.

When I arrived I asked the homeowner if they were interested in staying in the property if I could bring their payment back to $700 a month with them being a tenent? It was at that moment that I saw one of the biggest smiles I’ve seen in a long time. She was ecstatic about the idea and agreed to deed the property to my company.   In exchange, we would sign a 2-year lease option with rental payments locked in at $700/month for those two years. The stability in payments gives her a chance to stay in her home and my company owns the property without going through a foreclosure process. Upon some examination of the deal some investors would say I leased the property for too little, after all I have three other properties in the same neighborhood for $800/month. What I factored into the equation that if I proceeded with the foreclosure, I would face attorney costs, vacancy costs, repair costs to get the property clean and ready for the next tenant, and carrying costs without any income. In this case it was a true win-win scenario; I was able to lower the rent rate, save on the additional costs and most importantly help someone stay in the home the love.

My experience in note investing has taught me, when notes go from performing to non-performing that is the best time to evaluate each situation to see if there is a true win-win for both parties. Have experience a  similar situation? Share your success story. I appreciate your readership and your feedback.

Photo Courtesy: Pretty Sparkly Things

About Author

Kevin Kaczmarek is President of Capital Blueprints, LLC. Serving a national and international client base, Kevin helps clients achieve their personal goals for long-term stability and solid financial growth through Self Directed IRA Investments and individualized Passive Income Strategies.


  1. Great info on notes, and turning them into a win – win…. I have tried that approach in the past and most people who cannot pay do not pay on the Real Estate note even after deeding you the house… but it is much easier to evict than foreclose!

  2. Please Note that I am a novice (a curious one) .
    Did the property owner(now tenant) always make their mortgage payments on time UNTIL
    there payment went up to $975 ? If so , why not simply modify the loan to $700 vs. being a landlord ?

    • they did make them mostly on time when it was $700. Its jumped several times to the $975 and each time she progressively fell further and further behind. We could have done it that way as well, but this way was more satisfactory to both parties. She was very pleased to not have the burden anymore.

      • if the rent was below market and then raised progressively after you decided to bring it closer to fair market rent and they agreed they could meet those payments, how long were they in arrears each time you raised the rents? being a newbie, I wonder if the 30, 60 and 90 day overdue rules for credit rules were explained to them and then unfortunately when it became clear they could no longer meet repayments, how much more grace did you allow then, beyond industry best practice?
        at some point the business interest would need to conflict with the other interest, unless you were willing to carry them with other security to call on for their arrears.
        an unfortunate outcome which may have compromised the effectiveness of the optimal initial solution.

  3. you are what an ethical and moral business should be. someone who looked at the optimal solution, not the maximum profit. If businesses could all think this way, we would optimise outcomes for society and improve our net wellbeing always and true growth would be possible and world peace and progress too.
    I salute you.

  4. If the owners deeded you the property and you leased it back to them and additionally gave them an option to buy it back this is deemed to be a financing agreement. Be very careful that you don’t violate and usury laws. Also, you may not be able to evict for non-payment of rent since your tenants can claim an equitable title interest. You may have to do a strict foreclosure if they ever contest an eviction.

  5. 1. As you mentioned above you could refinance the note so that they could afford the payments. You could extend the amortization period or lower and fix the interest rate.
    2. You could reduce the debt to a manageable level and receive an option for part of the equity when the house is sold down the road.
    3. You could offer a significant discount if the owners could pay you off by refinancing in 90 days (or some other short time period). This could give you a great yield and help them lower their debt and secure a fixed monthly payment, but it assumes that they haven’t destroyed their “signatures” and can refinance.
    4. You could sell the note to someone else for more than you paid for it.
    5. You could use the note as a down payment to buy another property that you liked better.
    6. I suppose that you could have them deed you the property and then lease it back to them while selling an option to an unrelated third party or entity that they knew. Personally I wouldn’t do that. I like rentals and if I liked the property I might give them some cash to get them to move. I never want to lease back to a previous owner because the care of the property changes when they become aware that they no longer own it. I might move them into another rental and even upgrade them in the process or prepay part of the first year’s rent.

    If you have the opportunity to buy a very well secured non-performing note on a good property there are lots of things that you can do. The key is to talk to the current owners about their situation and problem and come up with several possible solutions so that THEY can agree on the best solution that meets their needs.

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