A Note Story - Summary of a note buying experience

16 Replies

Hey Bigger Pockets-

I wanted to post a summary of my latest note investment since I have been seeing a lot of posts about notes and how to get into them. I will start out by saying there are a lot of experienced note investors on this site who I have learned from so I am not trying to establish myself as the expert.  One of the reasons I wanted to post this is to give others an idea of the types of things that can happen to diminish your return.

Below is the note summary

Area: Outer suburb of Atlanta

Purchase Price: $7500.00

Broker Commission:$500.00

Unpaid Balance: $26,800.00   

Late fees: ~$28,000.00

Second position lien

First position lien estimated at $90,000.00

First position lien current with a few late payments per credit report

BPO: ~$140,000.00 at time of purchase

I prefer second position notes and that is what I have invested in primarily since I started investing in notes. As the market changes I am looking at changing my approach but for the sake of this summary I'll explain why I like seconds. If the borrower has a first position note that is being paid it tells me they have a desire to stay in the house. If there is equity above the loan amounts it tells me there is a reason for the borrower to stay in the house.  Those two facts help me feel more comfortable in my due diligence, there is a reason that the borrower is there. If I am pursuing a first position non-performing note I have no idea what is going on with the borrower. Do they live in the house? Are their any interior fixtures or drywall remaining? Are they just hoping to walk away? My goal definitely isn't to end up with a property that needs a complete rehab, my goal is to get the note to performing status and collect a regular paycheck. 

From prior note purchases I have learned that finding out what the homeowners motivation is should happen right away. So after the assignment for the note was complete I sent the homeowner a letter notifying them that I was the new owner of the note and that I would like to get her started again on a regular payment plan and that if we were not able to get this to happen we would initiate the foreclosure process. 

Initially, no response, so I engaged the attorney with an $1100.00 retainer to start the notices and filings. That got the homeowners attention. She called me and we talked at length about what she would like to do. At that time I gave her an initial option of paying off the loan for a discounted price of $14,000.00. I gave her some time to talk about it with her family and she called back the following week and reported that she wasn't able to gather the funds to make a payoff but that she would like to get on some type of payment program. 

One of the things that I had learned in the past was to have the homeowner tell me what they could afford in monthly payments so that they would look honestly at their finances and come up with a sustainable payment plan. Unfortunately the homeowner came back with $150.00 per month. I did some quick calculations based on the outstanding loan amount and figured out that at $150.00 per month she would never pay off the loan.  I proposed another solution for her, and I am sure this one will give more experienced lenders a laugh. I would do a loan modification with her that would allow her to pay $150.00 per month as a 0% interest loan for two years, at the end of the 24 months the loan would be reamortized with an interest rate of 10.75%, the interest rate on the current loan. My goal was; principal pay down, reestablishing credit worthiness for a possible refinance and to give her the opportunity to pay more than the $150.00 per month with the motivation that any extra payments it went straight to paying down the principal. She was thrilled. Very communicative, very willing to sign the loan modification...thought this was a great win-win. And I will add that this homeowner, unlike some was super nice.

We received our first payment in October, second in November, then NSF for the December payment. So we were effectively back in default after taking an excessive amount of time to go most of the way through the foreclosure process, then working out a loan modification, then getting her set up on an autodraft payment plan. 

I reached out to my servicer, who shall remain unnamed, and asked them to send notices of default to the borrower. The response, 'can't do that yet, she isn't 90 days past due. So I waited again. At about 60 days I reached out to the attorney to start the foreclosure process. The initial retainer had been mostly used up since we went though the motion previously. So, a new retainer was sent out for $1500.00 to start the process again. 

Summary of expenses at this point

Purchase and commission: $8,000.00

Retainer #1: $1,100.00

Loan modification: $300.00

Retainer #2: $1500.00

Mailing and filing expenses: $25.15

Monthly servicing fees ongoing

So round two of the foreclosure is started. This time I didn't go back to the borrower with the option of a payment plan. My intent was just to foreclose on the property and let the attorney handle all of the correspondence. The attorney sent notices, the borrower was very responsive and at this point was pretty much in agreement that she was stretched too far and needed a way out. So we proposed one final solution, she could pay off the loan at a discounted value of $16,000.00 prior to the end of August or we proceed with foreclosure. Leading up to that she would need to make payments to help offset the ongoing expenses. She agreed. 

So month number one of the agreement paid $750.00, paid the same again in months 2 and 3, however she was bumping up against the deadline to pay off the loan at the discounted value. Some time late in that process she ended up dialing me when she meant to reach out to the attorney to talk about making the final payment.

After a lengthy conversation I learned that after the first loan modification failure she had fallen behind on the first lien because she was having to make the decision between paying me the $150.00 or paying her first in full. Because of that I also learned that the first had initiated foreclosure so she stopped paying me in order to bring the first current. So she was really stretched as far as she was going to be able to go. During that conversation she mentioned to me that her house had been on the market but that she had two buyers back out and was worried she wasn't going to be able to meet the deadline for the discounted payoff. 

Me, trying to find a way out that would preserve some value for me and get her out of the property made her a cash for keys offer. Probably not my best move. First, I had no interest in owning a home in this area of Atlanta. Also, after making that offer I learned that the reason the deals had been falling through was because the A/C system needed to be replaced, the deck needed to be rebuilt and a couple of exterior doors needed to be replaced. Not to mention that as I got online and checked out the house it needed a substantial interior rehab. I was already seeing that I was going to be into this for way more money than I wanted to invest for a home that wasn't anywhere near where I wanted to own a rental and that my likely cashflow after repairs and paying the first position lien would be negligible. So back to keeping my fingers crossed that she was going to sell this thing. 

In the end she ended up selling the house, to an 'I buy any house company', I got a check for $16,000.00 and she got out from under the burden. 

End of the day

Total expenses: $11, 810.13

Total income: $18,550.00

Total time: 26 months. Not much velocity of capital here.

So this note resulted in a positive return, definitely not as much as I thought it would be. Do I think I could have squeezed the full amount out of the homeowner, possibly but my goal was just a healthy return. Should I have gone after a deficiency judgement? Maybe, but frankly the homeowner was just overwhelmed and needed a way out. How much more heartburn would I need to incur for a few thousand more? As they say, pigs get fat....

I am posting this mostly for those who are thinking about getting into notes. Make sure you have some capital reserves for your attorney. Set your note buying parameters, which I haven't touched on here. Realize those anticipated returns may not materialize as easily as you think they should. And make sure you really want to own the house because that might be your only option.  Good luck.

@Mark Gibbs I commend you for putting yourself out there. It takes guts to show the good, the bad, and the ugly. By my calculations (net profit/cost basis), your ROI was 57%. Annualized it looks like 26%. Healthy return if you ask me.

When I first got into the note business, I JV'd with an experienced note investor who had the same business model with seconds. I was a passive "ride along." After a while, this JV partner got to the point where he felt it made more sense not too push so hard. His reasoning was that if you put the right amount of pressure on, you get some cash flow but you don't incur unnecessary expenses. As long as the borrower kept up his payments on the first and paid down principal, our equity position became stronger and stronger. It also helps when the market's doing better. I still have have some notes with him and all but one are entirely in the money so it's worked out great. One day, we'll capture the entire payoffs instead of settling for less.

That strategy can work if you're using money you don't need right away (mine was SDIRA) but not if you need to turn deals to put food on the table. If you have enough of these notes, you can get into a position where you get enough cashflow. If you have only a few notes, you should really be using money that you can have tied up for a while.

Anything you would have done differently?

Originally posted by @Andy Mirza :

@Mark Gibbs I commend you for putting yourself out there. It takes guts to show the good, the bad, and the ugly. By my calculations (net profit/cost basis), your ROI was 57%. Annualized it looks like 26%. Healthy return if you ask me.

And thats the problem when you only look at a percentage return. I see the OP spending dozens (if not hundreds) of hours to make $6K in 26 months. Not to mention risking $12K of his money.  Just how much effort is $250 per month worth?!!!

@Anish Tolia I agree. One shouldn't just look at percentages and nominal numbers are important, too. Everybody's got different objectives and measure their successes and failures with different metrics. Sounds like the OP learned a lot. Maybe he's using this experience to perfect his business model. I don't know.

I like 1st position notes with a purchase price of $50k-$300k, which is a sweet spot for risk/reward including time spent. But that's just my opinion :)

Originally posted by @Anish Tolia :
Originally posted by @Andy Mirza:

@Mark Gibbs I commend you for putting yourself out there. It takes guts to show the good, the bad, and the ugly. By my calculations (net profit/cost basis), your ROI was 57%. Annualized it looks like 26%. Healthy return if you ask me.

And thats the problem when you only look at a percentage return. I see the OP spending dozens (if not hundreds) of hours to make $6K in 26 months. Not to mention risking $12K of his money.  Just how much effort is $250 per month worth?!!!

 Anish I do agree with U on this I can see someone trying this for the experience and fun of it.. but as an income producing investment not so sure.. it could easily have been a wipe out.. :)  the drama that goes into these types of notes and the time spent.. is hard to calculate.  

@Anish Tolia that is really one of the points of writing this. $250.00 per month is what I have made. Thank goodness this one didn't come with a lot of brain damage to get that. Would I take this as a performing note? Yes, and I wouldn't bat an eye. There are a lot of postings on the board that look at getting into a non-performing note at a low cost with an expectation that there is going to be a return equal to the unpaid balance and maybe even the late fees and that just isn't reality. This investment wasn't one that I needed to keep food on the table, but for others that might be the case. 

@Chris Seveney Yes, I know cringe worthy on more than a couple of items. I think I did my first note in GA about 5 years ago and I don't know if there was a licensing requirement at that time. I learned more about the licensing requirement half way through this note which was one reason I just turned everything over to the attorney during the second foreclosure process. When she called me I could, and should have just told her to talk to the attorney. I will say though that I learn a lot more about peoples motivations when I can speak with them directly. It is really hard to figure out motivations through an intermediary, it is also hard to figure out when you can push and when you can't.

@Derek Kirkwood No down payment on the first mod, that probably would have been my best first step and would have told me if she was going to be able to perform on the mod in the first place. My gut feeling was that she had nothing and that getting money out of her would be tough, I was right. Lesson learned.  

@Andy Mirza Other than the downpayment for the first mod and having the atty. handle everything, probably not much. 

One thing that I would strongly encourage anyone considering buying a note to do is stick to strict parameters.  As the market for notes has become much tighter asking prices are increasing. As you mentioned this was 57% return but it could have easily been 0% if I offered more or if I had more attorney involvement. I could have parked the note and ridden this out if needed but not everyone can or wants to do it that way. Someone else said this and I know I won't get the quote right but I am fine 'being an exception on the title, someday someone is going to come knocking on my door.'

One thing that stood out @Mark Gibbs is you modified the loan too soon. We go through a 6 month forbearance agreement where they need to put something down and pay something for 6 months to make sure they can even make regular payments and that typically comes off the accrued interest. We also like to give them a 2-1 reduction off the total due. For each $ they pay, we will take $2 off the total. You also did not lose money, so that is always Rule #1 for us, especially when we JV with an investor.

And we did a few workouts with $150 a month as we want them to get use to writing checks to pay off their debt after not paying for years. The last thing want to do is cancel a FC and they stop paying because they can't afford it. The idea was to get it paying for 6+ months and revisit, as maybe their income changed, or they want to sell, or can refi, or the value of the home as appreciated. I wish I had a crystal ball to see how something will workout and sadly, we don't.

@Chris Seveney why does talking to the borrowers make you cringe? I love working out a repayment with the homeowners that want to, we do the exact same thing on the ones that won't talk to us. A servicer can do it, though they do not care as much as the owner of the debt, and they charge a lot of money to do that, so unless you do not like smiling & dialing, a servicer can do the work.

Good case study!

Great post & insight to the workings of an NPN. I think more of these from investors would help the people who are interested in note investing. If anything, would help others learn from others mistakes/successes.