PERFORMING NOTE OUTCOME

26 Replies

Curious about realistic expectations for outcome of a performing note. Example - A note modified a year ago to lower payment and get borrower making regular payments again. New 15 year amortization at 10% and approx 165 payments remaining. LTV of 55%. P&I payment approx $425 per month.

In your experience, what is most likely scenario of this note? Borrower pays to end of note? Home is sold in 4-5 years and note paid-off? Borrower refinances to a lower rate after 4-5 years and pays-off? Borrower stops paying or falls behind again? Note holder sells the note after 1-2 years?

Just looking for thoughts based on past experiences.

Any one of those scenarios are possible. I would focus on the annual yield, know the other outcomes are possible. I don't think you can predict a borrower behaviors. 

Hello @Robert Harpster , great question.

I agree completely with @Cody Cox in that any of those outcomes are realistic possibilities. That being said, in the current low interest rate environment, we have been seeing a fair amount of homeowners refinancing and paying off their existing mortgages.

There is an element of randomness with respect to the outcome of a note which is completely out of your control. The main things that you can to do are to monitor and manage your risks (such as monitoring taxes, insurance, senior liens, HOA) as appropriate on an ongoing basis while you enjoy the cash flows that you are receiving.

Good luck!

@Cody Cox   @Fred Moskowitz

Thank-you for your replies. Being completely new to notes, does the servicer of the note report payment history on the borrower? So in other words is their credit score improving by making regular on-time payments increasing the likelihood that they will be able to qualify for a lower rate?

@Robert Harpster for loan mods on previously non performing debt, we usually require a substantial down payment from the borrower to grant the mod, like $5K to $10K to help ensure that they don't re-default. Statistically borrowers will re-default in 24-36 months, with $5-10K skin in the deal, that's a good deterrent.

Bob

Originally posted by @Robert Harpster :

Curious about realistic expectations for outcome of a performing note. Example - A note modified a year ago to lower payment and get borrower making regular payments again. New 15 year amortization at 10% and approx 165 payments remaining. LTV of 55%. P&I payment approx $425 per month.

In your experience, what is most likely scenario of this note? Borrower pays to end of note? Home is sold in 4-5 years and note paid-off? Borrower refinances to a lower rate after 4-5 years and pays-off? Borrower stops paying or falls behind again? Note holder sells the note after 1-2 years?

Just looking for thoughts based on past experiences.

As Bob points out above, getting a downpayment towards the loan mod generally helps as the borrower now has some skin on the game.  However, we have one that put down $8K (that she pulled from her 401K) but started faulting again at the 6 month mark.  We also have several that put nothing down but have been paying like clockwork for 18+ months.  Typically the longer the history of no missed payments the better.   

 

@Chad Urbshott

Good information. Being new to the note business I do not necessarily want to have a foreclosure on my first note. So I find myself possibly over-analyzing the property itself (buying the note not the property), the specific state and judicial vs non-judicial, the market of the neighborhood (appreciating, hot vs cold), and even the particulars of the borrower. The numbers are there and make sense. But I'm focused to much on the what if's.

Originally posted by @Robert Harpster :

@Chad Urbshott

Good information. Being new to the note business I do not necessarily want to have a foreclosure on my first note. So I find myself possibly over-analyzing the property itself (buying the note not the property), the specific state and judicial vs non-judicial, the market of the neighborhood (appreciating, hot vs cold), and even the particulars of the borrower. The numbers are there and make sense. But I'm focused to much on the what if's.

I don't know what the exact stats are and you have gotten reply's by experts in the business..  I seem to recall that re performing notes will default again within 36 months about 30 to 40% of the time..  I don't know if any of the folks who posted here will give you their stats.. and of course having just one note its hard to get a base line.. Bottom line though always be prepared to foreclose rehab and resell.. If you never have to great but if you do your not shocked.


 

Great tips from the top pro's, the only thing I can add is to keep in touch with the borrower, and let them know if they have problems, to let you know. We are all human & life happens, and sometimes they can't make a payment. Especially now if they are in a blue state still stuck on lockdown, and problems getting unemployment, like my wife's friend in CA. You can do it yourself if you have a few notes. After that, it's better to sub that out to (virtual) assistants and touch base with them quarterly or so. 

@Robert Harpster One of the easiest ways to mitigate your risks is by spreading your capital among several notes. When your entire investment is tied up with one note, you can really suffer if the worst case scenarios happen that you envisioned.

The reality in note investing is that there are some things you cannot control or know ahead of time. You won't necessarily know what the condition of the interior of the property is or what the borrower will ultimately do.

When you have more notes in your portfolio and you've done your acquisitions and DD right, the stronger performing investments can make up for the occasional outlier that doesn't do so well.

@Andy Mirza  

Thank-you for your comments. As a beginning note investor, I feel a performing first is the place to start. I've looked at payment history, online searches of property, equity, and verified taxes are current. Tried aso to get an idea of who the borrower is. I feel my next step is to order a BPO and then a preliminary title search.

@Robert Harpster , although everyone has their own process, most note investors will not order a BPO or title search until their bid has been accepted. You typically have 1 to 3 weeks for your post-bid due diligence (after you have reached an agreement to purchase the note but before you send funds). I don't want to spend hundreds of dollars on research until I have my bid accepted. But you are correct that a BPO and title report are two key pieces in the process. 

BPO's are next to worthless, just look on Zillow and find others that are similar nearby houses.  Assume your property is worse than others, possibly a lot worse.  If it looks like a dump outside, assume the worst inside.  Your estimate will be just as good as any BPO.   Maybe find a realtor who will go take a look at it for you, pay them $50.  Find one who has a house listed nearby, they will be in the area anyway.   I've had some success with this.  about 25% of them will actually do it, even if they tell you they will do it, a lot will flake out.  So get a few of them lined up.  

O&E report is a must (title search), after you have an agreed deal with the seller. 

Yes, I should clarify that I don't always order a BPO. Many times I will order an exterior inspection for $50 and run an AVM in lieu of a BPO. But you certainly need some way of estimating the collateral value.

I will say, however, that sellers (whether they should or not) will often give some value to a BPO if you are trying to use it as a negotiating tool when buying a note. So, they are not always worthless. But I agree that they can be way off. Ultimately, a BPO is simply an educated estimate that a realtor (often a less experienced realtor) is not spending much time on.

Either way, I am not spending any real money on due diligence until my offer is accepted.

BPO's are not worthless, the data is there it is how it is analyzed. Most realtors have no clue how to analyze a non performing note property. 

I see sellers provide BPO's all the time of 3 bed 2 bath homes in an area for $100k and the seller says - yep its worth $100k because that is what the agent says. My comment then is the borrower has not paid in 2 years, the homes in the BPO all have new kitchens, baths and hardwood floors. The REO's in the area sell for $40k. You really think this home would sell for $100k?

One way I approach this with realtors is to say "if that is what you think it is worth, then we will list it for that amount and if it gets a penny less you get zero commission". Can you believe every realtor I said that to said No? I said why, they comment that they have not seen the inside and its probably trashed. That is when the sarcastic side of me comes out and is like no #$% so why did you put a value on a piece of paper you know is worthless. 

Sorry for my rant I just went through this today with someone. 

Robert, I'm riding your coat tails here as I'm also looking at my first note deals.  Thanks everyone for all the good information.  The wealth of information and willingness to share in this niche of investing is impressive.

@Todd Powell

Welcome to the forum! Lot's of really good advice here. I have received really solid input form this group on how to purchase my first note. Research your questions in the forums as there is much information that can be found. Also reach out to this forum with other questions as these members have the answers. There is so much to learn about notes! 

Best of luck to you!

BPOs are not worthless and are essential to doing this kind of business. The big boys (loan sellers) rely on them for value. If you have a better BPO than theirs, you might be able to sway them on value. Otherwise, whatever the BPO value is what they consider to be the value of the property. They won't spend more time looking into it, which is to your advantage. 

BPOs are notoriously inaccurate. You should always review BPOs to see if the agent has been using best practices to determine value. Comps should be within half to one mile of each other, less than 6 months, similar square footage, bedrooms, etc. If the BPO wasn't done well, send it back and have the company review and revise it. If the agent did a good job and was limited by lack of comps, then you'll need to do more work to value the property.

For bidding purposes, Zillow or other AVMs are fine. During DD, however, you need more accuracy. Zillow and other AVMs tend to work best in cookie cutter, fairly uniform areas. If you're in more nuanced areas with large diversities in value, relying on an AVM is big mistake. Savannah, GA is one of the best examples of this. Values range widely from block to block. Even real estate agents have a difficult time valuing property there. AVMs are even worse.

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