Contingency-reserve fund when using investor money to buy mortgage notes

4 Replies

How much money do you set aside for contingencies (i.e.bankruptcy, unpaid taxes, evictions) when purchasing notes?

Also, how long should such contingency funds be held and should they bear interest? 

Hi Suzie

Frustratingly, the answer is "it depends"! As you know, there are a lot of moving parts in the notes business...and most of those parts cost money or create expenses before you see any income. The costs are driven by the type of loans you are buying and what you are trying to do with them.

Known Costs: these are costs you know when you are buying: Taxes (that the borrower has not paid), Water, Sewer, HOA and any other liens. Title costs, loan boarding and de-boarding fees (if you are moving servicer), servicing fees and insurance. These are the main items.

Estimated Costs: These are costs and fees that are driven by the nature of each loan. A simple performing first lien will have no extra costs other than Assignment creation and recording. However, if you buy a pool of non-performing seconds, you will have foreclosure fees, workout fees, legal fees, door knocking ....the list is pretty long. You can quickly spend 100% of the note cost on fees. So, you need to be certain that you can get that money back before spending it.

Foreclosures run up to $4k (depending on the state)

BK  will cost you at least $1k in legal fees

Taxes are known when you buy, could be zero could be $20,000+

Evictions depend on the state but can be $2k

I'd say you will need to hold them until you exit the note and I don't understand your question about interest?

Im not sure that answers your question!

If the property is vacant, include property preservation costs including bimonthly yard maintenance since many juristictions may impose a fine if the yard is overgrown. 

Performing notes - nothing to set aside. I've had hundreds of clients own notes personally or with their IRA and never come out of pocket a dime if the borrower stops making payments - we've just swapped them to a performing note. Non-performing notes - it depends, as @Paul Birkett mentions.

I have to admit this is cringe worthy.  So you are bidding and buy a loan with another person's money with little idea of the costs to disposition that loan?

Sorry to be so brutally honest but that is a disaster waiting to happen.  

How did you even make a bid on the loan if you don't know those numbers?  (see response above)

The question implies a desired X%.  A percent application idea like that doesn't apply to all loans as a loan for $30k is different than a loan for $300k and $3.0M.  

At face value I also do not garner a well understood framework of the liquidity of said accounts to be deposited into which bear interest.  Nor am I getting the impression we even understand the value of the interest.  You are talking 5 basis points on average and that term is likely closer to 9 months.  With limited capital you may not even qualify for the deposit, you certainly will not qualify for nightly sweeps.  

If this is just a question for curiosity's sake, great.  If you are trying to put this together you should probably stop before you get yourself in trouble due to lack of understanding.

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