NPNs for a newbie

21 Replies

Hey there.. Since this is my first post let me introduce myself a little. I've been a RE investor for many many years. I started with a singe SFR and worked my way up to multiples and then into fix and flip and general real estate practices sales, appraisals, you name it really. Since it seems fix and flip is getting harder due to dummies buying homes that need $100k of work with $20k margins have almost run me out of business locally (if someone knows how to make money that way please let me know maybe I'm the dummy?!), I've been looking online at other ways to find properties and make money doing what I am good at at know. I stumbled across this forum and the idea of buying into non-performing notes. I've done a lot of reading here but one thing I can't find is the doom and gloom (other than the people posting you could lose all your money) I can't find any tangible downside. So maybe some of you smart people can work through a scenario with me?

I'm looking at a note online, non-performing for 12 months or greater, it's a first position note with no other notes or liens (that I've found) Note is 5 years old, note is 250k, UPB is like $255k sale price for the note is 50% so about $125k. Value of the home is about $375k. Now I'm going on the assumption that the home is run down on the inside (seller's website has a good looking recent picture of the outside, no damage, looks lived in still) So maybe they are having a hard time selling it for $250k or maybe they lost their job and just can't pay.. Whatever, doesn't matter. My options are shortsell for below market value maybe 200k and I walk with 75K; renegotiate loan, reduce principal, payments, etc and get them refinanced under government programs after 3 payments, walk with $75k or more; cash for keys they walk, maybe I dump $50-100k in remodel and sell the home for market value at $375k and walk with as much as $175k; foreclose, spend maybe $10-20k on legal fees, remodel as previous and walk with cash after maybe 6 months of work or more?

Ok so I found the plus side which honestly seems too good to be true.. Now tell me the bad?  Where does this go terribly wrong?  Tell me your worst story from NPNs.

Im actually interested, and have been looking for sites for NPNs myself. If you dont mind me asking, where did you find the online resource, and what is it? 

Well, you need to know that putting the shoes on of a lender is not buying the property. Your cash for keys description may work, but the need to give you a deed in lieu of foreclosure for you to own the property. 

You are not entitled to profit from the sale at or after foreclosure, you are entitled to all amounts owing under the note plus costs of collection or foreclosure. The owner/borrower is entitled to amounts above what the lender/note holder receives. 

After foreclosure you can't just walk in and rehab the place, it's collateral, you can make a repair to safeguard the collateral, but don't start adding on unless you want to give the past owner more money. 

In Cali, you have a lien, not title.

might read this;

I know, it's a real pain in the back side to understand the basics of RE, especially after years of working with RE. 

Finance is not real estate, real estate is part of finance, it's an asset, in title states, an owner can sue for any gross excess amounts received from equity arising out of foreclosure. Look up "courts of equity". In reality, a lender isn't going to be keeping a million dollar property from a $100,000 lien or defaulted mortgage. 

It's the spin of mortgage brokers and the cheap prices that attract newbies to NPNs, that is not the place to start in note investing, learn performing notes first. Learn applicable laws.  

Hopefully, I just saved you $125,000 or so! :)

@Bill Gulley - let's discuss the matter of when a mortgagee does get "fee" with respect to title (and not for late payments, foreclosure proceedings, etc. for those who were thinking of that type of fee).

In the first paragraph of page two of this link, you will find an excerpt that I post below.

"By the middle of the Twentieth Century in the United States, only eight states - Alabama, Georgia, Maine, Maryland, Massachusetts, New Hampshire, Pennsylvania, and Rhode Island - still adhered to the theory that a mortgage conveys title to the mortgagee ..."

So would it be correct to surmise that in those eight states, that the note holder upon completing foreclosure does get "fee" title, and would not be bound to only recover amounts owed by borrower?  Or is there more to this "Lien Theory" vs "Title Theory"?

Can't say much with the details provided other than that there is likely more to the story, i.e. if seems too good to be true, it is. I don't know anything about California foreclosure law (or even if the property is in CA), but have heard that it is extremely borrower friendly, so you should talk to a CA foreclosure attorney before pulling the trigger. 

I would also note that I don't believe @Bill Gulley 's comment is universally true. In GA, at least, a lender that forecloses owns the property like anyone else and is entitled to profit from any equity upside. 

How can you lose? 

The first thing you need to confirm is the value of the property.. Are you familar with the area? and sure of the price of the home?  Some area properties are valued high but don't sell that high.. Similar to a diamond ring apprasied at $10,000 but you can only get $2,000 if you try to sell it anywhere..  I buy properties in Baltimore that zillow lists the value at $80,000 and the there are comps that show them in the $50k-$60k range but owner's can sell them for $25,000.  That's one thing you need to truly know the value of the property. 

Secondly,  environmental issues. If the house is old you could have buried oil/gas tanks leaking..  I've had homes were the clean up for $50k to $60k on a house worth $75k. 

One of the other things is a mortgage company worst fear. Bankruptcy.. Not liquation (Chapter 7) but the dreaded Chapter 11 or 13.   A bankruptcy judge has free rain to reduce both the prince amount you are owed and also the payment terms and interest rate you are due in certain bankruptcy cases.  This is called cram down.   It's very common in bankruptcy cases. Not to mention a bankruptcy case can easily drag out for 2-3 years with not payments to you are the note holder.

Originally posted by @Steve Babiak :

@Bill Gulley - let's discuss the matter of when a mortgagee does get "fee" with respect to title (and not for late payments, foreclosure proceedings, etc. for those who were thinking of that type of fee).

In the first paragraph of page two of this link, you will find an excerpt that I post below.

"By the middle of the Twentieth Century in the United States, only eight states - Alabama, Georgia, Maine, Maryland, Massachusetts, New Hampshire, Pennsylvania, and Rhode Island - still adhered to the theory that a mortgage conveys title to the mortgagee ..."

So would it be correct to surmise that in those eight states, that the note holder upon completing foreclosure does get "fee" title, and would not be bound to only recover amounts owed by borrower?  Or is there more to this "Lien Theory" vs "Title Theory"?

 In Lien Theory states, a lien is placed against title, a financial encumbrance where the owner retains title.

Title Theory states, a lender accepts title to property, retains title until the debt is satisfied. All rights of ownership in title are not taken, the owner retains possession and power of sale. After foreclosure the lender retains title, that doesn't mean an owner doesn't hold an equitable interest in the property. 

Collateral is to be sold to indemnify a lender or note holder (make the lender whole financially). 

Claims arise when an owner enforces their rights, seek indemnification for equity beyond what was owed to a lender. All states have "courts at law" and "courts of equity" which is in seeking justice rather than points of law. While a lender takes title in title states, their interest is to amounts owed and an owner may seek significant excess amounts of equity by asking the court to act on what is fair. This is why I said a lender wasn't going to be keeping a million in equity from a debt that's 10% of the value. 

I don't know that there is any set % for claims, I doubt it as it's going to be based on fairness rather than a dollar amount in title states. 

In lien states, the property or collateral is sold to indemnify the lender and excess amounts, to the dollar, is the owner's equity. A lender is not under any obligation, usually, to notify an owner of any sale or proceeds, the owner makes a demand of the lender. 

Either way, a lender should not be going in rehabbing collateral property, that simply increases the value that is to go to an owner in a lien state or can become amounts claimed in title states. 

The reason lenders don't move in or don't sell off the market is due to the lender's obligation to seek a fair value that may be due an owner, the lender is doing a little CYA dance by listing collateral on the open market or through an auction. Another dance is the deed used by a lender when they sell collateral, a Special Warranty or a Grant Deed or a Quit Claim (the only real exception to conveyances to third parties using a Quit Claim Deed). They are absolved of claims of equity in the property (but may be not to them as to how the disposed of collateral).  

After foreclosure a lender takes legal title with the power of sale and rights of possession. I won't go into the values a lender must carry the asset at, that changes in time, but while it is an asset, balancing the cancellation of debt, it is in limbo of sorts, in trust of sorts to be disposed of, why they call it "other real estate" or "real estate owned" which is different than real estate held for business purposes. 

Individuals are not banks or regulated lenders, but the theory of equity remains the same. Another issue, probably never spoken of by brokers, is the type of loan originated is made with specific and implied warranties by the originator, as notes pass through the hands of investors, those warranties don't just go away, the new note holder inherits them. The assumption of any borrower is that the collateral is sold to pay the outstanding debt, and this must be done for a lender to seek any deficiency judgment. 

The way to avoid all this in all states is for the borrower to offer a deed in lieu of foreclosure, acceptance of a deed granted extinguishes the debt and the lender may not seek any deficiency amount.      

Reality? Most who have a foreclosure walk away and don't look back, but I've found that when you're dealing with large amounts of equity, borrowers will be looking and if the collateral has unreasonable amounts of equity to secure a debt, the lender is at a disadvantage, not an advantage. :)

Thanks for that dose of reality, @Ray Slack . When you extrapolate circumstances to what could possibly happen, there is almost always a worse case than you originally thought.  And those 'worst cases' actually happen with unfortunate frequency.  

Also, Bill and I have had this discussion before, and @Steve Babiak brought up an exception that includes my area.  In the two states in which I work, MA and NH, once a mortgagee forecloses and becomes the highest bidder at the auction, and records the foreclosure deed, the mortgagee can do whatever they want with the property.  Including keep it, rehab it, rent it, profit from it, and so on.   At least according to my multiple local attorneys in those two states.  I have asked the question many times of many MA and NH attorneys.     I am not one of those attorneys so this is simply my experience.  It may be different elsewhere, I have no idea and don't presume to comment on CA.  

BTW - I do not claim any expertise on "Lien Theory" vs "Title Theory", and even those with some claimed expertise seem to differ in their list of states that are classified as one or the other. Link I used above was just because it was easier to cite a quotation. Below are some links with such lists.

See PDF page 22 (page numbering in corner is 16) for this link:

And I'm sure there are others ...

Something else that is important.. While problems are not that common maybe one in 50 to 100 loans..  If you get one of these problem properties/borrows/loans.  You could lose your entire investment..  Banks average this out risk over all their loans and it works for them.  1 total lose in 500 loans isn't that bad for a bank.

BTW another major problem can be that you are buying the loan documents of the lender that originated the mortgage.  Many lenders broke the law back in 2003-2010 by taking short cuts on these mortgages.  In florida they had robo signers. People that signed for the foreclosure company certifying that they reviewed the loan file and were certifying it correct.  It later came out that these signers never looked at the files and we signing 1000s of mortgages a day.. meaning that there was no way they could possibly have reviewed the file.  Once the mortgages came up to foreclosure the judges were throwing out the cases and it some cases wiping out the mortgage and giving the house back to the homeowner free and clear.

With reference to title vs. lien, Alabama is a title state but with non-judicial foreclosure. Lender gets title after the foreclosure auction.  Former owner has 12 month redemption rights in some circumstances, six months in others.

Good point on redemption rights as well. 

And, I'm not an attorney, I've been the Trustee in foreclosures, in fact, not until recently did our municipal judge need a law degree or be an attorney. Hmmm!

Not stirring any pot, but, please simply go to what I was saying, gross equity, not just 10 or 20% more, but where collateral taken outweighs the reasonable risk. Claims must be brought to court. Collateral and foreclosure isn't a "profit center" it's to indemnify the note holder for financial losses. 

I agree with Ann and Adam as well, until other factors become more prevalent. 

And yes, a cram down can hurt you and it's not just in bankruptcy. Another issue for NPNs is the past collection efforts made and a note becoming "stale" uncollectible. 

What's the state's statute of limitations for stale accounts, if the debt isn't valid, neither is the foreclosure. Mortgages usually go stale after a year, collection efforts must be documented, are you getting that in a loan file when buying notes? 

I should have defined "profit" a little better in my first post, I think my second one addressed that. 

Each state is different. :)

I've been investing in notes for years, and I can't believe you found a note where the value of a house is 375K, with the note being 255K for 50 cents on the dollar.  Maybe like 4 years ago.  These types of notes go for between 70-80 cents on the dollar these days.  If its online, I trust it even less.  Maybe that was the starting bid? or there is something seriously wrong with the collateral.  If its too good to be true, it probably is.

You really need to do your due diligent. My attorney told a storey of an attorney that bought at a trustee's same.

Turns out the parcel was land lock, and was protected habitat for the checkered spotted butterfly. All he could do was take a tax deduction for donating it.

See if you can get the note sell to provide a current prelin title, this will give visibility to liens. Good luck.

I like realtytrac for prospecting distressed properties.

This is an area in which I am currently working.

The downsides are:

- It's a cash intensive investment with little to no leverage and generally more difficult to raise money than house flippers / landlords. Everyone understands the concept of "we buy a house cheap, repair it and sell it for more". A lot of people fear lending money on a NPN because they don't understand it.

- It's very difficult predicting the results & timeline. It happens all the time that you buy a note thinking you're going to get a quick workout agreement, and 2 years later you're still working on it. Or you think you'll finish a foreclosure in 4 months and it takes 8.

- It's the Far West out there. A lot of sellers don't know what they're selling - it's only numbers on a spreadsheet for them. Sometimes it goes in your favor (ie you buy a 2nd and it's a 1st) and sometimes it's against you (you find negative things after purchasing it). At times it feels like a lottery, which is the opposite of investing. The ROI is what saves it. If you make 100% return on one note, it makes up for not doing as well on another.

And as far as foreclosures and keeping the money goes.. there is theory and reality. Some posters on this forum talk about theory while others talk about what really happens. In reality lenders foreclose, sell the house and pocket the money.

Thanks.. Really appreciate the input. Yes, I suppose the one I put there is merely a starting bid.. However even at 100% there is still room to make money. I hear what people say about not being able to pocket the equity, though I'm wondering if there's ways around that. A simple example may be just owning two LLCs, one purchases the note, forecloses and sells it to the other LLC for basically the value on the note and there's no need to be sneaky about it either especially as a real estate broker I can list properties on the MLS all day long and make it a "public" sale. Once sold off to another buyer than the note owner the original owner would have no claim to any additional equity. Also think in general it would be hard for any owner to make an equity claim against a distressed property, the whole world knows that a vacant distressed property sells well below market value. The value in the BPO's we all read assume a "sale" ready property, most sale ready properties follow closely with FHA guidelines. I have yet to see any FHA ready REO, minimum investment I've seen on any REO is around $10k and that's for a DIY. Call in a contractor and you're talking $20k. (this is the part of the market I know well) So at a minimum on said $375k BPO your actual sale price will be $355k (on a good day) because most home owners are going to want a move in ready property and most investors want more margin than $20k.. Throw in closing fees and you actual cash received is more like $320k.. If you added to that some legal fees for foreclosure, property taxes, and other misc. crap you can easily get down to $300k.. The rest well I think it's real easy to see how a supposed homeowners $100K in equity could disappear in a second in foreclosure without even trying too hard or cheating the system much. So long as you could justify it and show how said foreclosure really had no equity I think you'd be relatively immune from a lawsuit, which I think is how most banks as stated are getting away with foreclosing and keeping whatever equity they get. Equity is what caused this whole housing crisis.... Because what people failed to understand is that equity is just money on paper, it doesn't mean a thing unless you can actually cash it in.. And for said foreclosed homeowner, well your equity disappeared when you amassed a years worth of back payments, penalties, taxes, and then stopped doing maintenance. mind you I would say that sounds like a "normal" case to me. The case where there is a foreclosure on a first note where the home is worth 200K and the UPB is like 20K would be a whole different animal.

Also really appreciate the input on other possible issues, liens, mineral disputes environmental disputes etc.  Most of these can be found out and resolved by ordering a title search before purchasing the note...  Do you have an opportunity to do such after having an accepted offer on the note or do you need to do it before putting in an offer?

Another question, so I do realize that said notes are more like auctions curious how many auctions you have to lose to get one? These auctions seem closed, as in everyone submits their bids privately and the single highest bid wins. Are there some dummies out there like there are on the REO auctions that bid up way over what something is actually worth?


All great points. The cramdown is a real problem if it is an investment property, however if it is their principal residence, they cannot cramdown the principal. It seems backwards, but that's the way the chapter 13 works. Chapter 13's are not all that terrible if you don't mind taking payments.

I'm sure most of the people on here are looking for a cheaper way to buy a fix and flip properties, as was I when I got started purchasing notes almost 4 years ago. After a few knockdown drag out foreclosures, I realized that there may be a better way. We still buy nonperforming notes, but now we turn them performing if possible. There's a huge market out there for reperforming loans and I've sold them with as little as two months seasoning. One of the nice things about loans, is the multitude of exit strategies.

Nathan, sounds to me like you've worked through a lot of different scenarios all of which are good for you.

 I Buy nonperforming notes full time now and the only downside is If the homeowner is still living in the property he could file for bankruptcy, if you foreclose depending on the state could take you 12 to 24 months to get access to the property . But the numbers work it just may take longer than you anticipated to turn a profit

Just make sure you do all of your due diligence, doublecheck your taxes and title