1st reforming note go for about 40% of the unpaid principal

14 Replies

I have an opportunity to buy a re-performing first note at a 40% discount to principal The note has only 2 payments under a recent loan modification The interest rate is 5% and the principal is about 10% above appraised value The note has been serviced and modified thru a national service company . The effective interest rate is about 10% Assuming all the paperwork is in order what are the risks of making this type of investment vs the rewards 

Hi Steven, 

Assuming you have verified the value of the property, the integrity of the collateral and the existence of any other liens, the highest risk I see is re-default by the borrower. 2 payments is not many and I would set a baseline of at least 6 payments, preferably 12, since I think that the industry average is a high number of reperformers will default within 24 month after a modification. In lieu of waiting for the seasoning, you could negotiate some level of guarantee from the seller of the note that he/she buy it back if the borrower redefaults.

Bob

Thanks for the quick response @Bob Malecki  

 The equity value of the property vs the price of the note  is more appealing to me then the actual payments It was bought  in FC when they bought it and they took all the way to OOR with the courts.My understanding the foreclosure process would continue where it was left off I would be more interested in a foreclosure for profit .Is this a viable way to look at re-performing notes? Also I have read that a person is eligible thru the hamp program to refinance at a lower rate at just after 3 payments. The state  is a judicial state and the projected cost of the foreclosure  is about $5000 or less 

Like has been said, your risk is having to take the house back. Using round numbers your are a little over 70% LTV, just depends on what kind of investor you are, I wouldn't worry much about doing this deal if I was cash heavy, but I'm used to fixing them up and selling them if the worst happens. I guess the other risk is another 25%+ drop in market value, which is possible, but unlikely.

I'd also check your foreclosure laws.  Here in Georgia its basically a month or so process (gotta run 4 weeks in the paper before the sale, which is the first Tuesday of the month, so it depends when you start).  Other states take way longer and have redemption periods.

I'm with Bob, two months isn't seasoned.  Need to look the thing over and see what the problem was.  Might have been a financial hiccup, might be something they cant afford even with the remod.  Gotta qualify your borrower yourself.  You just cant rely other people to tell you they are good, especially when they are the ones trying to sell the note to you.

I'm with @Bob Malecki on this one.  The risk of re-default is high with no seasoning time.   I would do the following before pulling the trigger.

- Calculate your ITV to ensure that there is sufficient equity so that in the event of default you can recover your capital plus some extra for your trouble.

- Calculate your investment yield and adjust bid to hit a reasonable target yield. I would be looking for a yield in the high teens for something like this.  10% is not enough IMO.  You can do better.

- Negotiate a warranty period as Bob suggests.

Thank you for the excellent suggestions I was able to have a drive by done thru the neighborhood and it appears the appraisal value is solid . How do I calculate the yield on the reduced price? Is there a formula or calculator for this. Is it common to ask for a six month guarantee on payments? Do I need a lawyer for title search and to make sure all is in compliance with Dodd-Frank? Thank you again @Mike Hartzog ,@Darrell Shepherd and  @Bob Malecki

Steven

If I understand your numbers, let's say the balance is $50K. Then you are buying at $30K (40% discount), and the house is only worth $45K (10% discount). So now you are buying at 67% of value which is high with no seasoning and no warranty. You mentioned FC, well let's say you needed to FC and re-sell to get your money back, how much protective equity do you have? I use 85% of FMV as my quick sale price and to handle closing costs. Assuming you have no other costs other than your stated $5K (a big IF), your protective equity is 45K*.85-5000 holding - investment 30,000=3,250, which is not a lot of wiggle room to protect yourself. You need a bigger discount like Mike and Bob said.

The title search process would be like any for a property in your state. For example, in NC the title search (O & E should suffice) is done through a lawyer, while here in TX it is through the title company. For the price to achieve yield, you need a financial calculator (a good app or online search can work). Plug in all the loan numbers (final value = 0, months, payment), plug in your desired interest rate (NOT 10), and leave PV (present value) blank. There's your total offer price...be sure to subtract any fees from that.

Thank you all for the excellent suggestions I got this response from the sellers of the note

We don’t use credit as people in their position do not have good credit. Instead we look at how much money they can bring to a refinance, many times it’s $10-20K, and also their current paystubs to make sure they can afford a new loan. I have asked one of our Principals and the Asset Manager, about the seller guaranteeing 6 months of payments. I’ll have to get back to you on that.

The actual numbers are something close to this 

Loan original $400k not paid for several years

Modification  $300k  2 payments made at 5% interest

FMV $250k I have some boots on the ground and had a neighborhood drive thru'

Purchase price $170k

My biggest worry is Dodd-Frank compliance

Would any of you purchase this note and at what is price? 

@Ian MacInyre @Ken Martinez ,@Mike Hartzog, @Bob Malecki

@Steven Picker

  when you say its a mortgage state which indicates a judicial foreclosure...

you want to make sure you FULLY understand the process and timing.. right now the new laws require 120 days before you can even start a foreclosure.. most judicial states take 1 year or so... New York Forgeta  about it  LOL.

so if your idle for say 2 years it would take to run this through at 10% return you have 34k right there.. you have 2 years of tax's  force placed insurance ... Cost of foreclosing 5k you mentioned.. 4 to 6% resale fee... and how much damage are these folks going to do when they leave... could be nothing it could be vindictive damage at 10 to 20k.. you could find your self upside down ..

My experience with foreclosure bail out and  I have quite a bit of it... is within 24 months well over half of your payers will default and fall right back into the same Bad financial patterns that got them there in the first place.

In my mind there are SO many better places to make 10% with no where near the risk and I think your thoughts of foreclosure upside while a thought could be wishful thinking.

I have and will never be a loan to own guy... To much Drama... why not buy nice beautiful performing short term notes that yield 10 to 15%  ...

I think @Jay Hinrichs nailed it on the head The state happens to be New York, although the note owners claim that you can pick up the foreclosure process where it was left off your still looking a time delay, dodd-frank worries and damaged property.It makes me happy to stay a landlord I will have to adjust my strategy as I begin my transition into note buying Thanks for all the great input Bigger pockets is truly a excellent education tool 

@Steven Picker

You had asked how to calculate yield.  You can use a financial calculator but I find spreadsheets easier to work with.  To calculate yield, you need to have

- number of payments purchased (the remaining term)

- the P&I payment amount

- the amount you are purchasing the note for

With the above you can calculate your yield.  You can also use the first two values plus your target yield to calculate your bid/purchase price.  Here's a blog post which goes into the particulars of using Excel for financial calculations.  The blog references a sample spreadsheet which you can use to do both of the calculations I mentioned above. 

To calculate your bid/purchase price in the spreadsheet using a target yield, use the formula which returns PV.  Plug in your desired yield into rate along with the other two values.  The resulting PV is your purchase price.

To calculate your yield using the seller's asking price, use the formula which returns rate.  The value for Amount is your seller asking price.  The resulting rate is your yield.

Hope that helps...

From the numbers above, this would definitely be a pass....especially as some of the reply from the seller seems amateurish (leading to realistic concerns about DF). Credit should always be pulled and utilized to get a holistic view of the payor's situation if the goal is to get them to finish out the terms; this seems like they were just trying to alter its status to "re-performing" as quickly as possible.

Also, the notion that foreclosure could be picked back up....how does that make this a performing note? That's just not a very good salesman there.....:)

Notes can be very profitable, but likely not this situation (and you might find a new seller, too!).

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The primary risk would be that the borrower redefaults on the loan. You would need to be sure that you have remaining sufficient capital to go through the foreclosure process. On the surface, then numbers look good, provided the collateral value is solid and in good shape.

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