2nd Lien Non Performing Notes and Bankruptcy

19 Replies

As I educate myself on Notes, I would love to know what are some of the strategies and due diligence requirements when looking at 2nd Lien NPN and chapter 7.

Here is an example:

Sale Price: $8k

UPB: $100K

Property Value: $290k

Sr Balance: $400k

Sr Status: Unknown

Chapter 7 Bankruptcy / Discharged

So the property is definitely under-water and there is no information on whether payments are being made to the senior loan. My questions would be:

1. If the Sr is not reporting any payments, is there any other to confirm if payments are being made to Sr or a loan mod is being worked on?

2. Assuming payments are not being made, is it pretty much a worthless deal because most probably Sr will foreclose and wipe out 2nd lien?

3. What are some other strategies and due diligence one should do for a deal like this?

Would welcome any thoughts as I am just starting to learn this area.

Not even close to having any equity, discharged in bankruptcy, 1st is in default.....sounds like no value to me.  Unless both the borrower and senior lien holder are interested in working out a loan mod there's no chance of you recovering a dollar from your investment. 

Perhaps it would be better to spend $5,000 taking someone's NPN course rather than $8,000 getting "an education" on what is-and isn't - a good note investment.

You'll have the knowledge for a lifetime. 

I have a friend who does a lot of 2nd notes and it seems he's rarely able to get them to reperform. Usually, the play he makes is to get equity in the deal, basically, if the 2nd is above water, then there can be a big margin (although getting that money out isn't easy). 

With this loan, the 2nd is so far underwater I can't see any reason to go after it. The market's not going to appreciate that much any time soon and you don't really have a viable threat to foreclose as it would do nothing for you. I would pass. 

Hi Tehseen,

I have had several successful workouts with NPN 2nds and love them. I also do NPN 1sts. The due diligence you need regarding this is to confirm the 1st is indeed being paid and is current. This is the biggest deal breaker on the note you described. If you cannot confirm 1st is current, it's typically something to stay away from. That being said, just understand what you are getting into. The home is underwater, and the 1st mortgage cannot be confirmed, which makes for significant risk. I have completed workouts on underwater notes before, and for all my limited experience they are based on emotional equity not on equity in the property. However just understand that if equity is missing it simply removes an avenue of exit from the deal for you, meaning you cannot really "force" the borrower to resume payments, although he likely will if the modification makes financial sense.

Don't let the fact the borrower completed a BK chapter 7 scare you. I like those. It means they have less debt now, and usually more money to pay you. The thing that would kill the deal for me is the fact you have no idea if the 1st is current or not.

The lien is not necessarily stripped in a BK. It simply means the owner is no longer personally liable. You cannot go after him personally for the debt. However the 2nd mortgage still has the right to foreclose and evict the borrower from his home, so that in and of itself is leverage.

With all that being said I would avoid this deal unless you can confirm status of the 1st being paid and current. Lots of other more attractive deals out there. Don't confuse a cheap purchase price with a good deal.

Josh

Originally posted by @Christopher Montgomery :

@Rick Harmon

How is PPR npn course. Are you familiar with it?

 I have not taken PPR's course however the CEO Dave Horn came out and talked at The Note Camp event, which Ellis San Jose (aka The Note Guy) held at my ranch several years ago. I was impressed at how Dave explained PPR's training and investment model. 

Also in attendance was my friends Bill Tan and Gordon Moss, author of NPN book, 'Performance Anxiety'.

Although I have no immediate plans to offer note training, Gordon does offer an online course. I'm pretty sure PPR exited the info training space so you're choices are fewer. 

There are other however caveat emptor is essential. 

Thanks @Rick H. - That makes a lot of sense. You and others have kind of confirmed what I was thinking i.e. no value in the deal but I am coming across a lot of these. I would love to know some of the other sources of buying notes besides FCI and PPR if you can share here or PM.

Thanks everyone for their feedback!

Originally posted by @Joshua Andrews:

In my experience I am not aware of any other methods to confirm if the 1st is current and paying, other than the credit report or the borrower divulging that information. 

Call the 1st's automated system. This works fairly often and is one of the best ways to find hidden gems.

ie homeowner went BK, 1st hasn't reported in 4 yrs and seller is using the credit report numbers.

Originally posted by @Patrick Desjardins :

In my experience I am not aware of any other methods to confirm if the 1st is current and paying, other than the credit report or the borrower divulging that information. 

Call the 1st's automated system. This works fairly often and is one of the best ways to find hidden gems.

ie homeowner went BK, 1st hasn't reported in 4 yrs and seller is using the credit report numbers.

 Beware of any deferred principal on the senior note. If the senior note was modified, especially with HAMP, there could be deferred principal that is not declared on the automated system. This will erode equity and there is no easy way to know without discussing with the borrower since the deferred principal is agreed in a loan mod agreement which is typically not recorded for public review.

Originally posted by @Joshua Andrews :

Hi Tehseen,

I have had several successful workouts with NPN 2nds and love them. I also do NPN 1sts. The due diligence you need regarding this is to confirm the 1st is indeed being paid and is current. This is the biggest deal breaker on the note you described. If you cannot confirm 1st is current, it's typically something to stay away from. That being said, just understand what you are getting into. The home is underwater, and the 1st mortgage cannot be confirmed, which makes for significant risk. I have completed workouts on underwater notes before, and for all my limited experience they are based on emotional equity not on equity in the property. However just understand that if equity is missing it simply removes an avenue of exit from the deal for you, meaning you cannot really "force" the borrower to resume payments, although he likely will if the modification makes financial sense.

Don't let the fact the borrower completed a BK chapter 7 scare you. I like those. It means they have less debt now, and usually more money to pay you. The thing that would kill the deal for me is the fact you have no idea if the 1st is current or not.

The lien is not necessarily stripped in a BK. It simply means the owner is no longer personally liable. You cannot go after him personally for the debt. However the 2nd mortgage still has the right to foreclose and evict the borrower from his home, so that in and of itself is leverage.

With all that being said I would avoid this deal unless you can confirm status of the 1st being paid and current. Lots of other more attractive deals out there. Don't confuse a cheap purchase price with a good deal.

Josh

I included a link in the bottom that I based my reply off of.  In a chapter 7, it is possible that the 2nd lien was stripped correct? My understanding is that if it is stripped then you would not have the ability to foreclose.  Either way, would it be most prudent to look up their bankruptcy case, and then see if they had filed a 'motion to avoid' their lien?

As a sidenote, I recently saw a Chapter 7 file where a motion to avoid the 1st position mortgage appeared to be successfully passed because the mortgage company did not challenge it. This would mean that the borrower no longer has to pay the loan, but the company could still foreclose, correct?

 https://lvattorneyma.wordpress.com/how-to-strip-se...

Hi Tehseen,

Here is my understanding of 2nd lien BK scenario's so far. There could be holes in my knowledge as I learn something new everyday.

The first thing to clarify is there are two types of bankruptcies you will typically run into, although there are other less common ones.


CHAPTER 13

- This is a repayment plan or re-structuring of all debts if you will. Second position liens can be stripped through a motion of the court. This is typically when the home has negative equity. The lender has the right to contest this. This may or may not be successful. Also, in order for the lien to be stripped, the borrower must complete the BK plan. This rarely happens. But the short answer is yes, the lien can be stripped. Stripping not only wipes the debt from the borrower's obligation to pay, but also releases the lien from the property so you have no right of foreclosure to enforce a lien or recover collateral securing a debt. This is because there is no longer a lien.

CHAPTER 7

- This is the more common type of BK. It takes 6-8 months to complete. It wipes unsecured debt and certain other items from what the debtor owes, helping give them a fresh start. It's actually a good thing for 2nd lien investors. Because now they have less debt and more money to make payments on their mortgage(s). It technically makes the borrower no longer liable for the 2nd lien personally, as in you cannot chase the borrower personally for the debt. However the lien is still on title to the property, so think of it as the property owes you the debt. You as the lien-holder can still foreclose, evict the borrower from their home if they choose not to pay you or if you are unable to come to an arrangement that makes sense for all parties.

Couple things to note. There are a small handful of states where you CAN strip a lien in a chapter 7 BK. Georgia being among them. You need to do your research to ascertain if this is the case on assets you buy. The best way to do this is to check pacer . gov where you can review details of the bankruptcy filings to see if a motion to strip the lien was issued and if it was successful. You will also want to pull a title report on the property to determine of the lien is still on record and attached to the property. There are a few nuances here, but it's not rocket science. If you have a situation where your borrower has filed BK and is trying to strip the lien, you should engage legal counsel and not try to fight it on your own. 

As mentioned there may be some holes to my knowledge but that is my understanding of it so far in layman's terms.

- Josh

Joshua, great post. I did some more reading after I wrote last night and reached the same conclusion you did. In Chapter 7, you can file a motion to avoid a lean in any position right? Like someone could file on a 1st or 2nd. I think I saw in once case they filed only on the 1st, which I assume leaves the 2nd intact which should be even better for securing a workout, I think at least.

Originally posted by @Joshua Andrews :

CHAPTER 7

Couple things to note. There are a small handful of states where you CAN strip a lien in a chapter 7 BK. Georgia being among them. You need to do your research to ascertain if this is the case on assets you buy.

 This should no longer be the case since the BoA vs Caulkett decision. It supersedes the 11th circuit interpretation that liens can be stripped in chapter 7. 

That's why loans in Florida are a lot more attractive than they were just a few months ago - chapter 7 BKs are much easier than chapter 13s for the borrower. Now that they can't strip the lien in a chapter 7 BK, they have to complete the 3-5 years plan successfully which we know has a low success rate (~30% if I'm not mistaken)

Originally posted by @Steve Burt :

Joshua, great post. I did some more reading after I wrote last night and reached the same conclusion you did. In Chapter 7, you can file a motion to avoid a lean in any position right? Like someone could file on a 1st or 2nd. I think I saw in once case they filed only on the 1st, which I assume leaves the 2nd intact which should be even better for securing a workout, I think at least.

This I am unsure of. I believe the answer is yes, you can file a motion in many different circumstances. As an investor it is relatively rare to have this happen, although it is something you want to be aware of. I have not had motions for a lien to be stripped on my loans, but I know of friends who have. Just because the borrower requests the lien to be stripped does not necessarily mean it will. This is where competent legal counsel comes in instead of trying to do it yourself as mentioned earlier.

Hi Tehseen,

As noted above, I usually stay away from 2nds without any FME to secure my investment. I have had loans where I was in this situations before and what I finds that works is this.

  • Call the first and see what's up
  • Look for Lis Pendens from the first
  • If no Lis Pendens send a demand letter and wait 10 days, if no response
  • Begin to foreclose
  • This will flush out the borrower
  • If still no response, take the property with the first and rent it to recapitalize or hold for investment after a short sale.

There is always a way to make lemonade from a lemon. Good Luck

Call the first and see what's up  

How can you check to see if the first is current?

I've been researching np 2nds for about a month now and I've seen a couple of strategies but more truths that have been covered in the previous threads.

  • Invest in hot markets or at least stable markets.  This is key since it removes most if not at least 80% of the risk immediately.
  • Cost of obtaining + UPB of the first must be less then BPO or what you find on Zillow.

So considering those first two, if we believe we have an property in an area that will rise in price and/or foreclosing will result in a positive outcome. 

At this point, I'm trying to determine how much it costs to at least start a foreclosure to bring the homeowner to the table or complete it and still not be underwater in the property myself.