How to Calculate Payoff and Arrears on Non-Performing Note

20 Replies


I'm currently doing due diligence on a non-performing junior lien that has gone unpaid for about 5 years. I know the unpaid principal balance, interest rate, and monthly payment but the arrearages and payoff amount have not been provided... So I'm trying to calculate them. Here are the numbers:

Original Balance = $73,200

UPB = $64,000

Payoff Amount = ?

Arrearages = ?

Rate = 13.75%

Monthly PMT = $867.18

Late Fee = 2% of "overdue payment of principal + interest" <== Does this mean 2% of $867.18 is the monthly late fee?

Also, does negative amortization occur when the loan isn't being paid? If so, I'm thinking it would look something like this:

UPB @ last payment = $64,000

Payoff after first missed payment = $64,000 UPB + ($64,000 * 13.75%/12) Interest + $17.34 Late Fee = $64,751?

Or is there no negative amortization and your new payoff is just the UPB + late fees?

Is this the correct way to think about/calculate late fees, arrearages, and payoff amount?

Thanks in advance!

No, negative amortization doesn't occur when a loan is in delinquency or default.  A loan balance can only increase if the loan specifically calls for negative amortization or through a modification.  

The late payment fee described is 2% of the payment amount or $17.34.  

The calculation for the interest arrears is based on the amortization schedule so the date of the Next Payment Due is needed to calculate it since interest is not a fixed amount per period in a amortization schedule.  Your equation is not proper to find the interest arrears.  You can use excel to recreate the amortization schedule and sum the unpaid interest with the proper dates or there are some amortization schedules online if you don't have excel.  

The late payment fee is per payment until such time as the loan is accelerated.  Often times only applied 'if' a periodic payment is made (as opposed to an accelerated balance) - as in that payment was made and 'is' late.  Missed payments are not made and often times the late payment doesn't get added in.  One should still look to the note for confirming any terms with regards to the application of a late fee.  The contract will typically prevail.

Interest arrears is also governed by the terms within the note and local jurisdiction of the subject property.  Interest due prior to acceleration and then interest due after acceleration will both be addressed in a properly structured note.  Some notes call for default interest different than the stated note rate after acceleration.  Not all clauses in all notes are the same.  

Buying a loan that has been in default for 5 years could very well be a losing battle.  You need to check the statute of limitations on debt collection for the state of the subject property.  Many states are 4 years and attempting to collect after the statute has run is against the law.  The same statute may also limit the amount of interest accrued.  

If you really must know I would suggest asking the seller to provide the payoff statement for the loan.   That is a reasonable request for due diligence. 

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@Dion DePaoli  

@Wayne Brooks

Thanks. A couple comments:

I will certainly look into the statute of limitations issue that you mentioned. But I just want to clarify that being in default on a loan doesn't necessarily mean that the loan is in collections, right? So it could be totally feasible that the loan has been in default for five years, but has not been in collections for five years. I would think that the status of limitations would only apply to collections efforts, not to length of delinquency... I would also think that should I acquire a note that has such a statute, I could simply perform the state-required borrower outreach and then initiate foreclosure, right?

It sounds like both you and Wayne are in agreement that interest continues to be incurred on the loan balance when the loan is in default. However, you also state that negative amortization doesn't occur. I presume this means that although interest continues to be incurred, the interest is not capitalized to create a new, larger interest-bearing balance?

In terms of my interest calculation I'm essentially just using the following equation:

FV = PV * (1 + r)^n  

where FV = future value, PV = present value, r = the interest rate per period, and n = the number of periods

So using this, for the $64K balance @ 13.75% APR, after the first missed payment the new balance would be:

FV = $64,000 * (1+(.1375/12))^1 ==> $64,733.33 (or $733.33 in interest has been incurred)

Since you're saying that negative amortization/capitalization doesn't occur, I'm assuming that means that for each successive month in default the loan will accrue an additional $733.33 in interest. Or, said differently, you continue to accrue interest only on the $64,000 balance, NOT the $64,733.33 balance. I'm also assuming here that the 2% late fee isn't capitalized and is a fixed $17.34 per month whether it's one month late or one hundred months late. 

Some more clarification on the math of this would be helpful. I will certainly see if the seller can provide this information, but I don't see any reason why I shouldn't be able to calculate arrearages and payoff amount on my own with the information that I have. 

Who originates a mortgage matters, the borrower is entitled to somewhat of an implied warranty dealing with an institutional lender that their loan will be treated as required under that institution's regulatory requirements, subsequent holders treat the note under the requirements of that type of note, for example; an FHA loan will be subject to FHA requirements, a HELOC from a state bank will fall under FDIC, a private loan from an individual falls under state law.

You need to read the note to see how interest is to accrue, if it doesn't state that interest is to be added to the balance, then accrued interest is a separate part of the debt and does not accrue interest on the mortgage. 

Dion mentioned the statute of limitations, generally, on mortgages a loan goes to a non-accrual status after one year or at the time demand is made for full payment. 

An "APR" is only relevant when a note is made for closing or again when any other loan expenses are charged to the borrower as in rolling over an existing note, otherwise you are using the note rate and interest is calculated on a 360 day basis, not simply 12 months. The note rate /360 = interest factor X the balance = that period's interest charge. A non-accrual note does not add that interest to the balance to charge interest in the next period unless otherwise is stated, that interest does become part of the balance due over future periods until, by statue or regulation, it goes into a non-accrual status where interest is no longer charged.

When you make a final payment demand, the note holder is responsible for proving the amount demanded, as Dion mentioned local customs, what may be charged can be limited to what that jurisdiction allows, at least in good practice. Generally, interest after one year is not collectible as the note becomes dormant.

In making a demand for full payment, you need to be aware that any demand may be challenged and what you are asking for is prudent with respect to interest and late payments or other lender junk fees. Going to foreclosure you'll need to give an accounting and a copy of the note to the Trustee, this can be simply stated for the balance due, that depends on the Trustee and the jurisdiction. 

A mortgage held by a holder or string of holders, who fails to continue collection efforts will allow that note to become dormant or stale and uncollectible, it's not that the amount due isn't still owed but the security given can dissolve and become unenforceable leaving you in an unsecured status.  A borrower can also claim the note holder of a stale note abandoned their collection efforts resulting in the forgiveness of the debt. The right to foreclose becomes questionable and the jurisdiction becomes very relevant. You need to have servicing records when buying a stale note.

Anyone selling a note will give you the UPB in writing, that becomes a warranty, regardless of their disclaimers, since that is what you're buying. I don't think a novice note buyer should attempt to track the accounting of a stale note, you can rely on the UBP as it is presented. When you buy a note you should also get the servicing records, if there was an error in what the seller presented then you can go back to that seller. If and when there is a significant difference, you might be able to shout fraud. Anyone selling a note should also have the ability to repurchase it within a year, always!

You, nor we can restructure this note without much more information, the note and DOT, payments made, accrued interest charged, the jurisdiction and collection attempts or collection history.

My guess is that note is trash after 5 years! 

Along with any purchase price for a stale second you better consider the costs of collection and legal fees, and those can be lost along with the price paid for your great opportunity! :)  

The easy way out is to calculate the maximum due, declare the breach, initiate the foreclosure then mitigate and settle for a smaller number.

In essence, you "give away" something that you are not really anticipating receiving in exchange for a forbearance and loan modifixation during fire closure that includes clause(s) reassertion of the debt and Ted new terms.

This type mitigation gas both the affect as shivering your willingness to work with the debtor in good faith and further salidifies the debt should the bpdebtor escalate the mitigation into litigation, file BK or breach the forbearance, 

Even if you do not take further aggressive action to force sale, you would do well to send periodic statements to debtor in order to reminds them the debto is still due. 

Then, you can be a nice guy giving away interest that accrued but cost you very little.

@Bill Gulley

Thanks. So are you saying that this note is "stale" simply due to the fact that it's been in default for five years? Most of the tapes I look at have notes that haven't been paid in 5-10 years. Would you consider all of these notes to be stale and therefore unsecured/trash? 

I certainly wouldn't want to purchase a non-performing junior lien and then find out that it is in fact unsecured. The whole investment strategy with non-performing juniors hinges on the fact that while the note is non-performing, it is secured by the underlying property. 

In terms of your APR comments, are you simply saying that a defaulted note accrues interest on a daily basis (using 360 days per year) rather than monthly? This won't change the end result much at all as you're only changing the compounding interval, but it's a good thing to understand.

Lastly, thanks for the pointers on the importance of obtaining servicing records even on a non-performing note. I'll make sure that I request that as part of my due diligence. 

Eric, in response to:

- Statute of Limitations
SOL is slightly different in different states.  The tolling of the statute can commence from the day of the last payment or from the date of acceleration.  In some states the interpretation of the SOL is pro-borrower and others pro-creditor.  There is no distinction for a loan in collections vs not in collections.  All debts are in the process of being collected, some debtors pay and some do not.  The out reach idea - you misunderstand what that means - No.  In some states attempting to make contact to collect an expired debt will get you in trouble.  

As further cannon fodder on this idea, these second liens that are many years in default give rise to a lack of continuity of collection attempts.  A debt that is in default needs to continually be attempted to be collected or it may become stale giving additional defense to the borrower. This includes continually validating or making demands on the debt.  Often times all collection attempts on these loans have been halted at some time in the past.  Also, these files are usually stripped of all servicing records and the aforementioned correspondence making it more difficult to deal with counterclaims and defenses.

In regards to the calculation of the payoff amount you are understanding amortization.  
The loan:
Original Balance = $73,200
Interest Rate = 13.75%
Amortization = 300 (months)
Payment = $867.18

UPB = $64,000
Remaining Payments = 164

So the interest accrual is the interest due for payments 137 to 197 which is $41,172.83.  Using 5 years or 60 payments as the default term.  

As I mentioned in my first post, interest is not a fixed amount in amortization.  Nor is principal.  You are basing all of your presumptions on this this idea incorrectly.  $733.33 is NOT the interest due on every month.  $733.34 is the interest due for 137th month.  Interest due for 138th month is $731.79.  Interest due for the 139th is $730.24.  And so on to where the interest due for the 197th month is $602.01.

If you wanted to calculate it by hand:
1.  UPB*(Rate/12)=Period Interest (137th period starts)
2.  PMT-Period Interest=Period Principal (137th)
3.  UPB-Period Principal=Beginning Balance of Next Period (138th)
4.  Repeat 1-3 until the current loan period (197th)
5.  Sum the output (60 numbers) to find arrears.

All your math did was find the interest for one period, specifically the 137th period as dictated per the UPB.  

This would be pre-acceleration interest.  Essentially in order reinstate the loan the borrower still has to come up with $52,030.80 which is all 60 missed payments.  This can be at the lender's discretion allowing for a reinstatement amount suming to a lesser amount.

If we were to use the $733.33 for the default term we would have an interest due of $44,000.  While this may be a logical conclusion it is often seen as unjust enrichment to the lender as the lender would not have collected the additional $3k in cash.  

These matters are subject to court discretion and local jurisdiction.  Some jurisdictions have specific people (referees) or process in the complaint to calculate and affirm the interest due.

If the loan was accelerated, as I mentioned before the accelerated interest may be different than that of the note rate. Additionally, a note may contain language which calls for interest due from the last period due through the successive periods but often times that can be challenged as I mentioned. 

Anyway, so the payoff total would be the sum of those two numbers plus any advances and fees.  So before fees and advances we have a balance due on the loan of $105,172.83.  ($65k+$41k)

The late fee is a constant since the payment is a constant at $17.34.  In that case missing 60 payments would add $1,040.40 to the total.  Often times the full term of missed payments is not assessed.  

It is true you should be able to calculate all the figures provided you have all of the data.  In this particular case you need to obtain the advances that were made and understand what is allowed/common in the jurisdiction of the subject property.  That said, described here you can calculate most of it.  

There's my buddy @Bill Gulley !!

As I typed others posted.  Good stuff.

As to the idea that all or most of the loans reviewed are in excessive default terms - that is indeed the problem with the second lien street level investor arena.  They are, for now better description, - junk.  

As what is being pointed out here is common practice among the various state jurisdictions is going to vary.  Interest arrears can be limited especially when we start talking about these excessive defaulted loans.  

@Dion DePaoli

Gotcha. This helps clarify things a lot. 

I think you misunderstood me, or perhaps I didn't explain myself well. I do understand that interest incurred is a function of loan balance, interest rate, and compounding interval. I used one specific data point (UPB = $64K) just as an example. I'm not assuming that the interest is constant every month as you stated...

What is interesting about what you described is that the interest owed over the defaulted 60 months is the interest that you would have received had the loan been current. But that interest is not getting added to the loan balance or being capitalized, so the UPB has stayed the same.

In terms of "collections" it sounds like the note is considered to be "in collections" for the entire default period, regardless of whether there are outreach attempts made by the note holder or servicer. This makes sense. What doesn't make sense to me is how a SOL on the collection period could cause a secured note to become unsecured. At the end of the day, the borrower signed a promissory note for X and the lien on the property would exist unless a court mandated that the lien be stripped. In the case of a stripped lien, wouldn't the lien still be attached to the property, but not the borrower, similar to a Chapter 7 lien strip? So I could then foreclose on the property and the borrower would have the option to make the loan current, do a workout/modification, or move?  

Thanks a lot for running through these numbers for me, this really clarified how the interest and late fees are calculated and added to the UPB to give the payoff amount.

Sorry, I misspoke when talking about lien stripping. As I understand, if a lien is stripped, it is no longer attached to the property, but you can essentially still go after the borrower for the unpaid amount. Still, I could use some clarification on how a stale note can go from secured to unsecured... this seems like a major risk and haven't heard of something like this happening aside from a Chapter 7 bankruptcy. 

Again, depends on the jurisdiction, the type of note and yes, there is a lot of trash out there, roll the dice!

I was saying that the APR includes loan costs for the purpose of standardizing loans for comparison, interest isn't based on the APR but the note rate, just use of terms.

Unless a note was paid off on its anniversary payment date you'll have odd days interest and 360 days gives us that. 

Another note as to the UBP, without the servicing history how do you know that no additional payment was ever made, that will through off all your calculations, so just accept the published UPB.

A note isn't a revolving charge card, accrued interest doesn't bear interest over the term until defaul when all amounts owing may accrue interest until finally paid.....but then you have the interest accrual rules.

BTW, also check the usury laws for any second on residential property mortgages.

As Rick Harmon mentioned, the consumer loan can put you into loan mitigation requirements, you can play the give and take game, expecting less, but don't think your initial demand can be unreasonably or improperly demanded, because that will matter if there is litigation. 

You'll have additional days waiting for a reply from a borrower over an offer of compromise or modification, and the waiting period can be a year before you can lower the hammer. 

Where I see the market for these stale or dead notes is purely among brokers and investors, passing them around the table like a dealer playing blackjack. Except in this game the burned cards go back into the deck, investors selling to others through the broker. I'd really like to see the foreclosure success rate of these stale notes, those outstanding for more than 2 years.

I understand that many of these pools are simply be recycled by brokers. You might have a repurchase guarantee, but what goes on is that there is another investor willing to roll the dice, if these were in the securities market we'd call it churning accounts, an illegal matter and when a brokerage relies on other investors you enter the Ponzi scheme realm. The last holder standing loses. 

Usually, you get to play hide n seek, can you even find the borrower, that will give you more time to burn as well. Hopefully, the note will have a proper notice address covenant, many seconds don't when the lender assumes them to be short term financing or it was some hip pocket lender. 

You also didn't mention if this second was a cash funded loan or an equity loan by a seller, big difference on a defaulted seller financed note, but that's another game.

Need to really know who the Candy Man is, the holder and broker.

I doubt many individual investors even consider the possibility of forged notes, yes those are out there too!  Was the loan security properly perfected?

Frankly, you're much better off finding your own troubled loans locally, there are some, I guarantee it!

Seems most want to deal in their under ware at a computer, but if you get dressed and go the the Recorder's Office, you'll find plenty of paper to make a few phone calls on. Don't forget, you'll also see the address and borrower's name. I like to approach the borrower about getting out of that high cost mortgage and see if they will refinance. Then call the lender with an offer. Any discount of just a few thousand which is returned to you in a couple months sends your annual yield to the moon, and you might use that same money 6 times a year. 

Non-performing notes is a lot like elephant hunting with a BB gun, trying to stamped one into a hole. I guess you can tell I don't think this arena is for new note investors, you're usually in a broker's game. Buying a 5 to 10 year old note, I think the odds would be better without the brain damage at the race track! :) 

@Eric Jones The three guys above know much more about notes than I ever will, but a couple of clarifications.  What @Dion DePaoli was referring to in the stale/SOL conversation was that if no active collection Attempts are made after the triggering event (last payment or acceleration depending on where it is) for a certain amount time (usually 4-5 years) then the right to foreclose is lost. As to the exact loan balance with arrears, while you might need that for a proper foreclosure filing, it really means nothing to you as the note holder in 99% plus of these cases. You're unlikely to collect half, or any, of the UPB let alone any accrued interest.

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Wyane, you make it sound like there are the 3 Noteateers on here, LOL

Another issue, along the same lines of thinking of abandoned notes is where some holder 2 year ago gave notice and began the borrower's clock ticking on a foreclosure and never followed through, that can also lead to the loss of your security interest. 

Okay, there is another chance, I only had one small second note I held on to, about 7K+, it was in default, I did my collection thing, no payment, I knew the borrower was in poor health but not old, he had tried to sell the place, I just waited. I sent quarterly reminders, just to keep it current, never really pushed it. Then he had to go to a nursing home about 6 years later, the state forced sale and I showed up at closing to release the lien, got all my money. 

Nothing says you must foreclose, if the LTV is good, collateral is in good shape, your security interest is properly perfected and you keep the collection effort up, some day the property will probably sell and the title company will ask for a payoff. Non-accrual is in the foreclosure or book value of the note holder, a voluntary payoff can be the full bore amount due, so lucky you!

If you don't really need the money, let it sit under those circumstances, my note can last longer than the borrower will!  :)   

Adding interest to a loan would be compounding.  Not typical among mortgage/dot notes.  Again, default terms may, as Bill mentioned as well, provide different terms.  The moral of the story here is with the variety of jurisdiction and the variety of note language among the differences between funding in cash and equity the notes will be less homogenous than what most tend to think.  It is not one size fits all.  

Running the SOL doesn't specifically unsecure the note.  It does however disallow collection attempts on the debt.  In that sense, it is similar to a BK discharge.  A debt that is discharged does not automatically mean the lien is removed or unsecured.  The lien may still be enforceable as a cloud on title providing for some potential collection.  This of course is barring counter-claims to quiet title.  There are two different ideas at work, the collection or pursuit of collection of a debt and the validity of a lien.  We can leave some of that for a latter discussion.  You should be relying on legal counsel and a licensed debt collector and/or servicer to engage on these matters to ensure you are compliant.  

Just to add the additional idea of lien stripping.  Stripping is the legal act, usually order by court, to remove a lien from title.  That is the removal of that lien, that is all.  Lien stripping and collectability are not the same thing.  A lien can be stripped and the debt still collectable.  A debt can be discharged by court or statute and a lien may still be valid.  (Until successfully challenged)  A discharged debt being uncollectable has more to do with the pursuit of collection and less to do with equitable recovery of a lien.  We will quickly voyage down the rabbit hole here so that is probably all the commentary needed.  

As we have pointed out, these long term defaulted notes pose risks to investors that they do not fully understand.  The condition of the file greatly adds to that risk as most are skinned down to bare bones and the buying investor doesn't know any better.  The success rate of second lien default collections can be somewhat understood by virtue of authentic secondary market pricing.  Unsecured defaulted debt trades for around 2% of unpaid balance (not total due) and secured between 3% to 5%.  In that sense, worrying about defaulted interest accumulation is somewhat a moot point.  If you can collect $3,200 on this loan you would have hit a home run.  Like baseball, most players do not hit home runs at every at bat.  Some don't hit any at all.  

@Eric Jones BTW, 2 numbers that are likely much more important than the actual total debt on the 2nd.....the current value of the property, and the outstanding balance on the first....if those are upside down, it's likely irrelevant how much is owed on the 2nd.

@Wayne Brooks

Agreed. The FMV is $145-165K. Senior is at $64K and junior is at $63K UPB, so there's plenty of equity. It also happens to be in my hometown and the property can easily rent for $1500-1600. It;s a nice neighborhood and one of the top school districts in the nation, so it would sell or rent very quickly. Did a drive-by yesterday and it's a house that I'd be happy to own if I had to foreclose. My preference would be to work with the borrower to help them stay, if that's what they want.

I'll be calling the New York Attorney's office to make sure that the UPB and arrearages are collectible considering the statute of limitations that we discussed.

Thanks for your help guys!

I agree consult a foreclosure attorney and have him review it.  In Florida we have many 1st and 2nd mortgage that the borrower didn't make payment on for years and since the bank didn't take action to foreclosure after 5 years the debt became un-forecloseable. It was still a lien on the property but the bank can't foreclosure and the owner can basically stay there without paying forever or until they try to sell it.

Well they really can't sell without paying off the loan. Unless the buyer doesn't have title work done and doesn't get title insurance. Which rarely happens these days.