Well, didn't expect this topic to be what it is when I read the title.
Allow me to shed some reality on this topic.
Jumbo loans less likely to be in a securitized trust, is not true and misleading. First understand, there are two fundamental types of residential loans. Conventional and Non-Conventional. Conventional simply means eligible to sell to the GSE (Government Sponsored Entities) or Fannie Mae and Freddie Mac. Further, not to be confused with FHA, VA, USDA, etc loans which are Ginnie Mae loans, those are non-conventional. Non-conventional simply means NOT edible for sale to GSEs. Next concept, just because a loan is eligible, does not mean a loan is sold to GSEs. Fannie/Freddie are considered investors, they are certainly the largest in the secondary market but they are no the only ones at all. The GSEs are not portfolio investors, in other words they do not hole the whole loan on their book, they securitize it. This is why we have conventional guidelines and they are a big deal, those are the minimum set of guidelines a loan must have in order to be sold to FNMA/FMCC and those GSEs pool the loans into securities and sell to the public. They are not the only investor who did this either. If you recall, Ginnie Mae, through FHA, issued a jumbo loan amount increase to $729,750 in 2009 to help with market recovery. Ginnie Mae, does not hold loans in portfolio, they pool and make securities. Anyway, point is, jumbo loans are just as likely to be found in a security than non-jumbo.
So we go off looking for jumbo loans. Because the loan is larger, we then expect the profits to be higher as percent of loan balance or even property value. Well, as a dollar for dollar, the profits will be relative. 20% profit on a $50k home, a $100k home and a $1 MM home are all 20%. The cash itself is different. The unfortunate thing here is the profit dollars can be higher but so can the loss. Losing 20% on a $1 M home, simply is not anyone's idea of fun. Losing 20% on a $50k home is not great either but it is not $200k. So sending newbies, with little to no skill off to work on assets which can swallow them whole, is simply irresponsible. You want to learn? Start small.
So the property needs to have negative equity. Fine, not all that uncommon. The bid equation they list is 80% of FMV less your profit. The 80% is derived from some magic capacity to refinance at 80% LTV. This is a load of horse-pucky!
Jumbo loan LTVs move down as the loan amount goes up and the documentation of the borrower decreases. No where in there did they talk about how to size up the borrower to see what they can afford. Many jumbo loans were written as stated income loans. Well, those programs are not so popular. So this teaching presuppose that all borrowers must be able to prove their income and assets to qualify for a new loan in the first place. A dangerous assumption.
The refinance exit here also assumes, the market is teaming with banks/lenders who will refinance the borrower to begin with. What of the credit history of the borrower? If they were delinquent, their credit is not so good. Jumbo loans require higher credit scores than non-jumbo to move the needle on LTV or interest rate.
Now pricing the acquisition of the note. (80% FMV minus 20% Profit=60% FMV) So essentially, they say you can swoop in and purchase a performing loan or sub/re performing loan for 60% of FMV. Most of the jumbos are in the state of California by nature. California is a non-judicial foreclosure state. The non-performing value of that loan is higher than your 60% bid by 8% to 12%. The funniest thing is, they are teaching you to just wipe out 20% of equity. Guess what, that portion of equity they just told you to wipe out (to get to 80%) your profit is inside of that not on top of it. So their bid sucks and their evaluation method sucks, plainly stated.
Next the falsehood that you somehow can work with the borrower and mortgagee at the same time. That is wacky. A mortgagee is not going to open up to trade with you, exposing the borrower's private information and allow you to be in contact with the borrower. That is a huge violation of privacy policies of all major lenders/banks and is a disclosure in most loan packets. Not to mention the default risk this creates for the mortgagee. As a mortgagee, I have you messing with the borrower's head thinking that all this principal can be forgiven through this refinance. When the refinance fails because the borrower can't qualify for a loan, they borrower usually tries to go delinquent again, thinking if they act like a child the bank will modify their loan, not realistic.
The funnest part of this part is the dislocation of reality these gurus send you on. Look, as a mortgagee, when a loan is being refinanced, a payoff statement is issued. This is tracked and usually alerts any loan sale to remove the loan. Essentially, what they are saying (assuming their crap is true), the mortgagee will get a payoff request has no idea about the FHA program they are trying to use and will unknowingly sell you the loan when the same 80% recovery of FMV is at their finger tips. Sure bud!
I am glad you asked about risk. The way to limit your risk, do not follow this plan. Certainly refinance is a disposition strategy and should be explored. a Short Refinance is at the top of the list of disposition strategies for loans as it represents the highest best recovery execution next to paid in full. Everyone knows this, including those guys that call themselves banks who write loans.
All of the major components of whole loans are missing in this plan and education. Evaluation and analysis, due diligence, the full spectrum of disposition strategies, mortgage servicing, fair debt collection activities and how a transaction really flows. Loans do not trade like real property.
Hard money is not easy to find to use to purchase notes. If I was a seller, I would not transact with you if you were buying one loan using hard money from me. It is a potential waste of time, you do not have discretion over the money, you can not decide to purchase or not, the lender does. Therefore, you are not the real buyer, they are.
If you want to learn the note business, which is more complicated than real property in its nature, then spend some time as suggested in this thread on BP. There are plenty of discussion around various fine points to the space. I tend to find myself commenting in many of the threads so look at my posts. Also a good guy to read on is Bill Gulley, tons of experience with loan regulation and examination, etc. There is no fancy names in the discussions, like "Back-flipping" that is sales crap. This would be a short refinance, short meaning the mortgagee took less than what was owed on the note. Refinance meaning...refinance.
As my post is getting long, let me knock down some chatter that went back and forth in the thread quickly.
A bank has not duty to sell loans at a discount for the most part. Loans sell at a premium or par or discount. Discounted loans are a function of equity, performance or defective collateral for the most part.
If a loan sold for 20% less each time a new investor (likely not a bank) purchased the loan, the loan would hit ZERO in 5 trades. That is not how it works. Does a house value fall to zero the more it trades? (no)
The bank regulation for specialty reserves, cash reserves for non-accrual loans, has been addressed for the most part by many of the still open banks. Selling loans was not a requirement of this concept, it was a strategy. Simply raising additional capital to match the reserve obligation was also a strategy.
Jon was right, they are not selling these at a high enough discount to easily make this work. You as a newbie have a better chance of doing business with a Private Equity firm that holds notes not a bank. That said, the purchase price of a performing current loan is going to be based on default risk and prepayment risk. They did not teach you how to analyze that which are loan fundamentals.
As far as the size of the discount, it is relative to the recovery of the principal of the asset. This is affected by geography, performance, borrower credit and time. A non-performing loan in New York trades for less than the same loan in California because it takes 3 times longer to foreclose. The secondary market was created to trade loans at par and premium, there is no mandate for a discount. The less default risk the less of a discount on a performing loan.
Is what they propose possible? To cause a short refinance as a mortgagee, absolutely 100%. Are all of the details missing and many aggressive assumptions being made, yes. This is as I said above the ideal strategy for return, do it quickly and recover the portion of discounted principal in a short amount of time. Great, easy stuff. They just take a bunch of liberties with the way a refinance and loan sale cycle will happen.
As a loan buyer and seller, I can tell you nobody hands my firm easy profits. It is hard work. I don't take too many self proclaimed liberties, but I am not new to this industry and pretty darn good at what I do. If I was your seller, you are not getting any silver platter profit from me. That doesn't mean you are getting a bad deal, but I am not handing you a layup when I can do it myself, that loan would not make the sales floor. We would short refinance it. That said, some larger firms miss stuff, so there are diamonds in the rough, thus the "have to work for it".
