Non-performing second with first in forclosure

17 Replies

I am a note newbie who was reviewing a recently released tape of non-performing seconds.  I noticed that with this tape, there was very few that were behind performing firsts and nearly half of them listed the first as in foreclosure.  Approx another half listed the senior as not recording on credit or outdated.  Obviously, these loans were very inexpensive but other than that, I am having a hard time understanding the advantage to purchasing a NP second if the senior loan is listed as under foreclosure.  Can anyone shed some insight into this?  Do these get purchased just in the hope that the first gets reinstated or does a loan mod?

Hi Sandy

You don't mention it in your question but I'll assume that there is no equity cover for the second lien. If thats the case, your only hope (as the future owner of the second) is that something happens to stop the FC sale. 

That "something" can be either:

1. The first gets reinstated or permanently modified.

2. The first agrees not to move forward to FC for some other reason (working on Deed in Lieu with borrower, short-pay or some other solution).

Even if the FC is stopped (for now), it can easily start again. So you need to understand what the likely next 180 days looks like from the homeowner and lender point of view. No lender wants to FC and no homeowner wants to lose their home....but sometimes there is no other way out.

Example 1 - No Equity to cover first: The home is worth $50,000, first lien is $125,000, second lien is $20,000 and FC has been running for 6 months already. 

In this case, there is no equity to cover the first or the second and the chances of the second collecting anything is remote. The homeowner may not see any way out (as he is so far under water) and the first may not be inclined to work with the borrower (for whatever reason). This could be a total loss, but you may collect some nuisance money to release the lien so the title is clear for the next buyer.

Example 2 - No equity to cover second: Home worth $50,000, first is $50,000, second is $20,000. FC just started 2 months ago

In this case, there is some hope. The homeowner is motivated to find a solution and the first has just started the FC file. There is a chance that a deal could be done with the first. 

1. Can the homeowner afford to reinstate - check the credit report: is he employed, have cars and other assets that could be sold to finance the payments?

2. What state is the loan in - NYC 5 boroughs: 5 years to FC. Texas : 2-3 months. You may not want to wait around forever to see a return

Example 3 - Some equity to cover second: Home worth $50,000, first is $40,000, second is $20,000.

This looks good right? The first will get paid off in full and there is $10,000 to go towards paying you in second position......but wait....its not that simple:

Lets say the borrower was 180 days delinquent before the first started FC (thats the minimum in most cases). They may have advanced the taxes for the year and also have the costs of the FC

So, 6 months payments on $40,000 will be around $1500, plus late fees of another $200, plus unpaid taxes of $1000, plus corporate advances to cover the cost of FC $3,000 is a total of $5,700.....leaving just $4,300 to cover your $20,000 second. 

You may have paid 15% of UPB or $3,000...plus servicing, recording etc of $400+....leaving you with a profit of under $1k.

In many cases, the first will have waited longer and advanced more funds to cover legal letters etc etc....so it transpires at the FC that there is nothing to cover your second position and its a total loss.

If you are looking to purchase these assets, you will need up to date credit reports and you will need to have a good idea of how you are going to get out of the deal before you get in. If you cant see a clear exit...there may not be one

Paul

Originally posted by @Sandy Uhlmann :

I am having a hard time understanding the advantage to purchasing a NP second if the senior loan is listed as under foreclosure.

Those notes don't all end up in foreclosure. Afaik the main play is helping the homeowner do a short sale, which requires approval from the second mortgage holder (you). They also often end up getting into an agreement and not foreclosing. If there's equity they can also just outright sell it.

I don't think there's really great value in seeking these out unless you can buy them dirt cheap and you know how to work them. It's more a case of bigger volume buyers getting them as part of pools and then trying to unload them.

I actually think it would be a great business model, same as credit card debt etc. The only problem is it takes a different set of skills than what we're used to. Managing a NPN 2nd with current 1st is pretty straightforward and everyone understands it. Not a lot of people understand the concept of buying the lowest of the lowest inventory, literally one step above unsecured debt.

@Patrick D. @Paul Birkett

Thanks for the input.  That tape was recently released from PPR.  That was the first time I had seen so many seconds being sold behind firsts that were in foreclosure.  I assumed that there must be a niche somewhere.  I guess if you could gather some info from somewhere so you KNEW that the first was being worked out then it would be well worth your while but otherwise, it seems like a huge gamble.

I don't invest in NPNs but I'll throw my thought in here.  It's probably worth what you paid for it!

If one could ID properties with good equity in this situation, this niche could be a gold mine.  To scale a valuation method would be absolutely awesome.  If investing country-wide I would think you would need boots on the ground who could go by and physically view the property.  BP may make that possible!  Without equity, I would think any investment would be throwing good money after bad.  Gotta find out if there is sufficient equity in the underlying asset @Sandy Uhlmann .  

What would be sufficient equity to justify the risk?  When I used to help folks facing foreclosure I had to (in general) have equity equal to 5x the amount of arrears I was coughing up.  That's a dead business model in the new world of DF and SA, etc.   So I would need not just a little equity - but about 5x amount you invest may be a goal.  Good luck!

Originally posted by @Sandy Uhlmann :

@Patrick D. @Paul Birkett

Thanks for the input.  That tape was recently released from PPR.  That was the first time I had seen so many seconds being sold behind firsts that were in foreclosure.  I assumed that there must be a niche somewhere.  I guess if you could gather some info from somewhere so you KNEW that the first was being worked out then it would be well worth your while but otherwise, it seems like a huge gamble.

Again, I think it would be a great niche but I see two issues that make it so I'm not personally getting involved with it:

1- Low margin so you need to spend as little $ possible on fixed costs (boarding, servicing, legal) and basically do everything yourself or build a team. Which leads into..

2- Volume. Since the margin is lower and you're going to lose on many of them, you need to deal in volume and that means you have to do it full time (since you can't afford to put 100 FC notes in 3rd party collections)

I'd love to get other people's input on this. 

@Sandy Uhlmann   think this through... who is going to make money on this deal... its the one selling the note to you right.. they shift what is a pretty complicated process with very small dollars from themselves to you... they make their money and never do the heavy lifting they switch that to the unsuspecting and beginners in the market place.. who I suspect many will just walk away and call it a learning experience.

There are too many other GOOD and safer and far less complicated investments for one in my mind to remotely consider this.. Unless you have millions to throw around and you buy in bulk then off load to the next sucker.. that's my thought   :)

@Steve Vaughan

@Paul Birkett @Patrick Desjardins   you boys are obviously professionals at this... do you think mom an pop investors should be trying to do this in a very small scale.. ?  seems a waste of time. .I totally get the doing it for a living and having millions in the market at anyone time and a staff to help etc.. but I personally just don't see how this is a niche for mom and pop investors.. unless they just want to go through a very steep and arduous learning curve for basically the fun of it.

@Jay Hinrichs

I don't think there is a straight answer to that question Jay. 

This thread is focused on buying low value loans very cheaply and hoping to find wheat amongst the chaff. That can be high risk for the new investor as they are more likely to miss something in due diligence that could cause a problem down the road. 

It really depends on the person. If someone is very detail orientated, takes their time, purchases slowly and really enjoys the learning curve (which is steep and binary - ie lots of opportunities to lose all your money) then anyone can do it. 

The other thing to watch out for is the legal and regulatory environment. There are lots of opportunities to get in trouble here too.

You absolutely need to know what you are doing. There are no short cuts - - it takes a lot of time and effort to learn the basics. Once you are an expert a single investor can build a portfolio of 2-300 loans and run them like a well-oiled machine. 

In summary, its not for everyone: much more complicated than many RE transactions but more scalable too

Paul

I guess we all started out as Mom and Pop investors in this 2nd position note space. Some folks went on to build it up to a lifetime endeavor while others stayed with their current form of income. The beauty of this level of investing is the application of due diligence that is required to "stay alive". While there are easier forms of investing, there is rarely the huge upside potential that the 2nds space provides and once DD is mastered, you can not unlearn true DD that can be applied to any project taken on in any field in the future.    

It just seems to me that this would be a very risky purchase.  Aside from the equity position and maybe looking at the credit report, I'm not sure how to do the due diligence to determine if the first is going to do a loan mod or whatever it needs to do to rise above the foreclosure.  Additionally, it seems risky to hope that if the first forecloses, you might come out with some cash at the foreclosure sale.  Once it goes through the FC sale, aren't all the junior liens wiped out?

It is all about pricing, there are no bad notes just bad prices. When I purchase, I will put internal prices on all selected notes. Some at a high price and some at zero or 1% then I see the average overall price for the combined pool and submit my offer. I always throw a few free ones in like the note you are talking about and take a shot. You would be surprised how few notes actually get wiped. People all need to live indoors and have an amazing bounce back ratio.

Good luck  

Originally posted by @Jay Hinrichs :

@Sandy Uhlmann   

do you think mom an pop investors should be trying to do this in a very small scale.. ?  seems a waste of time.

but I personally just don't see how this is a niche for mom and pop investors.. unless they just want to go through a very steep and arduous learning curve for basically the fun of it.

 I totally agree with you that it's not for the new, passive investor.

We're talking about people who want to get to get to the next level though.

To me it seems like the last frontier. The prices have gone way up for "easy" distressed assets (ie high / low balance 1st mortgages, 2nds current on the first with equity etc).

But won't these really low end assets always sell at a good discount, and as a result be appealing to those of us who do or want to do it full time?

I wasn't around before the crisis so I have no clue how the market was in the past. That's why I love people's feedback and experience. I want to prepare for 3-4 years down the road when you can't buy premium assets for 20-25 cents on the dollar.

All great points, I am active in this space and had made a decent living finding this product for my investor friends/ partners. I think there is good money to still be made sourcing these deals direct from banks, servicers, funds etc. I dont buy from the usual suspects that are available, I dig a little deeper. Hope this helps

Originally posted by @Sandy Uhlmann :

It just seems to me that this would be a very risky purchase.  Aside from the equity position and maybe looking at the credit report, I'm not sure how to do the due diligence to determine if the first is going to do a loan mod or whatever it needs to do to rise above the foreclosure.  Additionally, it seems risky to hope that if the first forecloses, you might come out with some cash at the foreclosure sale.  Once it goes through the FC sale, aren't all the junior liens wiped out?

One way to find out about the first position is to get the borrower to give an authorization to release - but you probably won't / can't get that before you become the note holder. 

Although the junior lien is wiped out when the senior lien forecloses (and did everything right of course in foreclosing), the note obligation's promise to pay survives - you just don't have any collateral that secures the note after the senior lien forecloses. I think that was the point @Patrick D. was trying to make in one of his posts - you become a debt collector like a credit card collector. 

If you have limited experience with notes pass on these notes.

Find a performing first with a non-performing second.

Make sure you have equity in the deal and have a plan

should you have to foreclose on the second.

You might be better off doing a couple with a seasoned investor

before attempting one on your own.

What ever you do make sure you get the original signed note

not a copy.  Know the laws for your state and whether  it is

a judicial or non-judicial state. I would advise you consult with a attorney

that has experience in this area.

Because of Dodd Frank there are certain procedures you have to

follow to foreclose.

Well This post started over 2 years ago, and I am still going strong in the note business. I started this business pre meltdown 3/2007 and we had plenty of product if you knew where to look and I see that to still be the case today. You need to adapt to the changing world, make new connections, broaden your network and you will have product.

I want to see if BiggerPockets is the place for that broadening of my network.