Payment and LTV percentages

14 Replies

I’ve heard investors say you should stay away from low payment notes. I’m wondering the rationale. As long as the yield is acceptable, I’m thinking what does it matter? I guess it could limiting because of you want to accelerate your notes, could you do a partial?

A related question is is there a risk for buying a performing note with very low LTV? It would seem a borrow would likely not want to walk away with that equity.

It seems suspicious to me if there are still a lot of years left though.

With low payments, the servicing fees can take a large bite out of your yield.  

As for low balances, some  borrowers seem to be less inclined to pay the entire amount off since it's a pain to pursue them and expensive to foreclose.  However what some of these borrowers do not realize is that they cannot sell the property until the lien is released. 

@Peter Halliday   There are four main areas where a small payment might concern some investors.  These don't always apply but could be behind that blanket statement:

1. A small payment can equate to a small balance on a low price-band property.  The property value can sometimes be an issue for investors.

2.  The costs of servicing as mentioned by @Chad U. and the cost of acquisition can take big bite out of your yield. When we buy notes we run our gross yield using IRR and then our net yield. We take into account the net payment (after the servicing fee) and also the costs of acquisition for title/BPO/closing/recording.

3.  The cost to pursue legal action on a small balance note on a low value property can quickly have you bumping up against the top-end value of the property. 

4.   There is the "hassle" factor of doing the same amount of work, due diligence, and servicing on one small note that you do on a larger note.

If you factor all of that in and you are happy with the asset then small balance notes can be a great place for a private investor to make good returns. Many of the institutional investors tap out below $40k leaving opportunity. They can also help grow a small dollar Self-Directed IRA. If you can buy a smaller note at a discount and offer an incentive to the buyer to payoff early you can really accelerate your returns.

Many times, not always, lower balance loans are on lower value valued properties, which have lower quality borrowers with a higher chance of failing. To pursue collections in those cases requires time & effort, which could have been better spent on a higher balance loan with more there to collect. 

As Chad mentioned, higher servicing fees take a bite out of your returns. If the note goes non performing, your foreclosure fees represent a bigger percentage compared to the market value of the property. FC fees, for example, might typically run $5k-$10k in a certain state whether the balance is $10k or $500k.

Also, when taking a property back as REO, you have almost the same fixed cost of doing a $10k-$20k minimum rehab on properties in the $20k-$150k range.

Great comments. This is what I expected so far. So in situations where payment is low but LTV and ITV are ow too then not as much of an issue, but where the LTV is high and thus the ROI in worse case could be even underwater quickly it's an issue.

Further it makes sense that the emotions of getting a couple hundred dollars is different than getting much more.  

@Peter Halliday

Typically it’s because people overpay for these assets. Many investors bid off of a percentage discount and not based on the return yield.

Some also do grow cash on cash and not net (not sure why) and do not take into consideration servicing fees

I also tend to zig when others zag and have a lot of loans with low payments and low balances- they are easier to sell and many get paid off early as borrowers who owe a few thousand bucks may pay it off early.

Tracy, do you have a ball park for what the Title/BPO/closing/ and recording is?
TIA
Originally posted by @Tracy Z. Rewey :

@Peter Halliday   There are four main areas where a small payment might concern some investors.  These don't always apply but could be behind that blanket statement:

1. A small payment can equate to a small balance on a low price-band property.  The property value can sometimes be an issue for investors.

2.  The costs of servicing as mentioned by @Chad U. and the cost of acquisition can take big bite out of your yield. When we buy notes we run our gross yield using IRR and then our net yield. We take into account the net payment (after the servicing fee) and also the costs of acquisition for title/BPO/closing/recording.

3.  The cost to pursue legal action on a small balance note on a low value property can quickly have you bumping up against the top-end value of the property. 

4.   There is the "hassle" factor of doing the same amount of work, due diligence, and servicing on one small note that you do on a larger note.

If you factor all of that in and you are happy with the asset then small balance notes can be a great place for a private investor to make good returns. Many of the institutional investors tap out below $40k leaving opportunity. They can also help grow a small dollar Self-Directed IRA. If you can buy a smaller note at a discount and offer an incentive to the buyer to payoff early you can really accelerate your returns.

 

Lot of syndicators use interest-only loans for couple of years which are low payments.

Think the reasoning is that you're increasing equity thru prop appreciation and value-add without debt reduction.  That way you can juice up the current CF.

Originally posted by @Nick Taylor :
Tracy, do you have a ball park for what the Title/BPO/closing/ and recording is?
Great Question! That will vary by state and whether you obtain title insurance versus a title report.  Here is a ball park estimate of costs when purchasing an existing Note/Deed of Trust or Note/Mortgage:
Title Report: $100-$200
Note: If you want title insurance instead of just a report then it will be much higher and the title company will base the premium on the amount of title insurance.  It’s possible to save hundreds of dollars on title insurance premiums if there is an existing mortgagee’s title policy insuring the note holder. The easiest way to check is to get a copy of the HUD-1 settlement statement or closing statement from when the seller sold the property to the buyer. Then look for the closing costs related to title insurance.
BPO $100-$150
Closing: $250-$500  - This varies on whether using in-house closing, title company closing or attorney closing.
Recording Assignment: $50

@Tracy Z. Rewey Just wanted to add to what you wrote about title insurance.

During due diligence, we always check that the loan had a lender's title insurance policy issued when the loan closed. We need to see the title policy with the policy number. If it was just a commitment for title insurance, we dig deeper to make sure the policy was actually issued.

If it was not,  we look into how much getting a title insurance policy that covers the loan prior to the date of closing costs. Usually this is not an issue and the price is reasonable. If it were an issue, then that would be a huge red flag and we'd drop that loan from the trade.

I would not buy a loan that could not qualify to get a lender's policy after the fact and you'd have a hard time finding someone willing to buy it from you. In that situation, your loan is less valuable and you run the risk of dealing with any potential issues yourself without a title insurance company to back you up.

Originally posted by @Andy Mirza :

@Tracy Z. Rewey Just wanted to add to what you wrote about title insurance.

During due diligence, we always check that the loan had a lender's title insurance policy issued when the loan closed. We need to see the title policy with the policy number. If it was just a commitment for title insurance, we dig deeper to make sure the policy was actually issued.

If it was not,  we look into how much getting a title insurance policy that covers the loan prior to the date of closing costs. Usually this is not an issue and the price is reasonable. If it were an issue, then that would be a huge red flag and we'd drop that loan from the trade.

I would not buy a loan that could not qualify to get a lender's policy after the fact and you'd have a hard time finding someone willing to buy it from you. In that situation, your loan is less valuable and you run the risk of dealing with any potential issues yourself without a title insurance company to back you up.

I agree with you.  I have been accused of being old school on wanting to be sure there is an existing lender's title policy or order a new commitment for a policy to be issued at closing.  Title reports can work as a way to see what has happened since the policy but they don't replace a policy.  They are not insurance.  It's just a report.  Sadly I have seen many of the title report companies miss important liens or exceptions. I have found a provider that will deliver a title report with a level of title insurance (sort of a mixed product).  I have used that on some smaller balance notes.

@Tracy Z. Rewey You were probably accused of being "old school" by someone trying to convince you to buy paper without a title policy because they wanted to close their deal without any added expense or hassle. To me, that's not "old school." That should be common sense and a trusted counter party shouldn't give you any crap for it!

Originally posted by @Andy Mirza :

@Tracy Z. Rewey You were probably accused of being "old school" by someone trying to convince you to buy paper without a title policy because they wanted to close their deal without any added expense or hassle. To me, that's not "old school." That should be common sense and a trusted counter party shouldn't give you any crap for it!

Right?  I have thick skin so no worries.   I think though that it goes beyond that.  There are quite a few newer investors that will buy without seeing the old policy or getting a new one.  In the seller finance world it might be they just didn't get title insurance at the sale so we have to go back to recreate.  For bank originated notes that have gone through the waterfall of hedge funds or private equity funds it could be missing collateral docs.  If an investor has assessed the risk of buying with just a title report then that is their choice.  My concern is the potential for new investors to not realize the difference between a title report and a lender's title insurance policy.  

 

I think anyone who buys Notes w/o title insurance either doesn't understand the risks or has more money than sense.