For those investing in mortgage notes, what factors do you consider most important when evaluating a potential deal?
Beyond the purchase price, how do you weigh things like the borrower’s payment history, property value, equity position, interest rate, remaining balance, loan-to-value ratio, and property location?
For investors who have purchased both performing and non-performing notes, have your evaluation criteria changed based on your experience?
I’d also be interested in hearing from experienced note investors: What is one red flag you now look for that you may have overlooked when you first started investing in notes?
Would love to hear what others have learned through actual deals.
We always talk about the three P's, which are the person, the property, and the predicament.
If it is performing, then we will look at:
- pay history
- property value
- title
- overall performance
If they are a steady payer.
We mainly play in a non-performing space, so that is different. We want to understand very similarly to performing, but go a little bit deeper, such as the predicament: why did they stop paying? Someone typically does not wake up one day and just decide not to pay the mortgage.
We also want to understand the person:
- Have they filed bankruptcies 7 times?
- Do they have a 17-page rap sheet?
- Are they litigious?
Many factors involve understanding the borrower.
Last, of course, is title, taxes, and any involuntary liens on the property. Want to make sure those are clear.
The other thing that is not often discussed is who the seller is and how they have been handling the note, such as:
- Are they self-servicing or using a third-party servicer?
- Is that third-party servicer a decent servicer, or are they awful to deal with?
A lot of things to consider. I could talk about this all day long.
We always talk about the three P's, which are the person, the property, and the predicament.
If it is performing, then we will look at:
- pay history
- property value
- title
- overall performance
If they are a steady payer.
We mainly play in a non-performing space, so that is different. We want to understand very similarly to performing, but go a little bit deeper, such as the predicament: why did they stop paying? Someone typically does not wake up one day and just decide not to pay the mortgage.
We also want to understand the person:
- Have they filed bankruptcies 7 times?
- Do they have a 17-page rap sheet?
- Are they litigious?
Many factors involve understanding the borrower.
Last, of course, is title, taxes, and any involuntary liens on the property. Want to make sure those are clear.
The other thing that is not often discussed is who the seller is and how they have been handling the note, such as:
- Are they self-servicing or using a third-party servicer?
- Is that third-party servicer a decent servicer, or are they awful to deal with?
A lot of things to consider. I could talk about this all day long.
One of the biggest red flags to watch out for when buying NPLs specifically are the corporate advances, which are generally comprised mostly of legal fees. The higher they are, the more litigious and uncooperative the borrower is, which can draw your timeline out on recapitalizing the investment dramatically.
I come at notes from the other side. I create seller financed notes here in Texas when I sell on terms, so I've learned what makes my own paper worth something.
Payment history is king for me. A borrower who has paid on time for a year or more, with a servicer who can prove it, is worth more than a prettier rate with a messy record. That's why I put every note I create on third party servicing from day one. The paper trail is the value.
After that it's equity cushion. If the note ever goes bad, the property has to be worth clearly more than what's owed, in a market where I could actually sell it.
Red flag I learned to watch: a note where the underlying senior loan and the wrap aren't documented cleanly. If the paper doesn't tell the whole story, I pass.
