Nine Exit Strategies When Dealing With Defaulted Notes

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After you buy a defaulted note, you could always contact the borrower and act like a traditional bank, but if you do, expect the conversation to go adversarial rather quickly. What do you expect when you tell someone, “If you don’t pay up, we’ll just Foreclose and you’ll have to get out…”?

Yes – but there is a better way.

Want the “magic formula” for talking to a borrower who isn’t paying his or her note. It’s simple, just ask:

  1. “What happened?”
  2. “Where are you at now?
  3. “What would you like to do?”

I’ve always had much more success – financially and emotionally – when I understood the financial situation of a borrower. Think about it, when you know your tenant has a good job and a happy home, don’t you worry less? Doesn’t that make you feel safer when you think about cashflow?

For us, the initial conversation with the borrower generally sounds like this: “Do you want to stay or go? I think I can help you with either decision. Look at me as your advocate.  If nothing else, I think I could save you from having a foreclosure on your record.” I’ve always felt that it’s good to stress that “our legal department will be moving forward until something is worked out,” so the borrower knows foreclosure isn’t something you want to happen, merely that it’s the only option left on the table if there is no communication or if a favorable deal for both parties can’t be agreed upon.

If the conversation is strained in the beginning, we train our asset managers to say, “Listen, even if we agree to disagree, just give me five minutes to show you how I’ve helped other families in situations like yours and if you don’t want to talk to me after that I’ll never bother you again.” This usually gets the borrower to start listening, which is sometimes the hardest part.

Once a dialogue is established, we then proceed to go over some of the homeowners’ options by telling them stories of how we’ve helped other families, utilizing solutions like the following:

Nine Strategies To Help You Get Paid

  • Discounted Loan Payoff –This is when you accept less than the face value of the note for a payoff.  We always offer homeowners an opportunity to pay off their loans without incurring the additional late fees and penalties that have been added.  An example would be, if you paid $20,000 for a second mortgage with a face value of $50,000 and you contacted the borrower by mail and said,” if you pay $30,000 in the next 60 days, the loan will be considered paid in full.”

    This is a major strategy employed by low equity note buyers.The conversation with the homeowner might go something like this: “There’s a family I helped in Oregon where they were able to access their 401K penalty-free because they were in Foreclosure.” What if the person doesn’t have a retirement plan? Then we could say, “Maybe you’re qualified for the friends and family program.” Then I would go on to tell a story of a family in Delaware I helped where they didn’t have a retirement account, but the borrower’s uncle offered to pay the discounted loan payoff amount.

    If they don’t have ANY friends or family that could help, the next option might be more practical…

  • Reinstate Loan – The delinquent loan is considered reinstated when the amount of money needed to bring the past due loan current has been paid.  This is also called “arrears.”  Sometimes a partial reinstatement or discounted arrears plan is put into place with the homeowner. If they’re on the fence about putting money towards arrears, we point out that the more they pay off the arrears, the better offer we can make with length of terms, payment amount, etc.
  • Payment Plan – Sometimes called a “Loan Modification” or a “Forbearance Agreement”.  Many loans have more than one exit strategy and I describe this as “moving in all directions at once.”  It’s better to employ several options to exit the deal until the first viable one appears.  A typical plan example is a payment plus arrears like described above.  This plan would typically spread the reinstatement amount over a defined number of months along with the regular or reduced payment.
  • Refinance – Another typical plan instituted with a delinquent borrower is a full or partial reinstatement and regular or reduced payments with the goal of refinancing.  This could take up to twelve months of re-performance and would usually require sufficient equity in the property.  These plans come in an infinite number of combinations, but of course they all require that the borrower must be able to start making payments.  If a refinance is not a viable option, you may assist the borrower with credit repair or by hiring an attorney to do a loan modification on the senior lien and help by providing a corporate advance.
  • Seller Assistance – If the borrower can’t afford to stay in the property, you could assist them by helping to pay for the Realtor, a mover, a down payment or even rent for a new place.  You could also allow them to stay in the property and buy them some time until the property gets sold.  You could even pay the homeowner if they were to find you a buyer or tenant.
  • Deed in Lieu of Foreclosure – If the homeowner cannot afford to stay in the property and there’s little or no equity you could offer them an administration fee, often called “Cash for Keys”, if they were to sign over their deed (their ownership rights) to you. The “Fresh Start Program” is when you provide them with a portion of their equity in the property, up front, as a means to make a fresh start and move on from their current situation.  Please note this program is only available on the condition that there’s equity in the property.  These types of programs can save the Homeowner from having a foreclosure on their credit.
  • Foreclosure – This is when a mortgaged property enters into the possession of the mortgagee without right of redemption by the mortgagor, usually for reason of delinquency of mortgage payments.  Many times you’ll initiate foreclosure to get a borrower to surface because it’s always better to exit working with the borrower.  This is only used as a last resort to protect your interest.  You can even work things out with the borrower after foreclosure in some cases.  That said, all notes are purchased under the premise of having to use foreclosure as an exit.
  • REO – Real Estate Owned, the final stage of foreclosure process when the bank or lender (you) takes back the property.  Then you usually sell the property (“As Is”) to recover your investment.  You can then try to liquidate quickly by contacting investors through a National REIA group (Real Estate Investor Association), or a BPO Realtor (oftentimes you can use the real estate agent who did the drive-by appraisal when you first bought the note) or REO broker (www.REOredbook.com is a great source we use)., If you want a top agent, you can use a Realtor with the CRS designation (Certified Residential Specialist – www.CRS.com, the top agents in the country).
  • Sell the Note – Whether re-performing or non-performing, you can sell the note since it’s an asset and that’s always an exit. One of the best ways we’ve found to sell re-performing notes is by offering some type of warranty or discounts. You can find note buyers all over the country; some of the best places to go are local REIA or Meetup groups. There is also a large amount of buyers online with places like LoanMLS and a variety of LinkedIn groups. And like raising private money or investing in general, you can also create a market of note buyers simply by educating people of the advantages of owning notes.

So what options do you give the borrower? Comment below with tips and techniques you do!
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About Author

Dave Van Horn

Dave Van Horn is President at PPR The Note Co. - an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

3 Comments

  1. Hi Dave,

    I enjoyed the article. You mentioned buying the second position mortgages. Isn’t there a ton of risk with a second versus just buying first loans at a discount??

    Do you make more money holding your notes long term or flipping notes?? Example you buy for 30 cents on the dollar and flip at 50 cents on the dollar relative to value. This way your capital keeps churning just like houses with rehabs and flips versus buy and hold.

    I guess you could mix it up and occasionally hold the really good notes over time and flip the rest.

    Are you worried about the safe act or that some owner financed residential loans were not originated and serviced correctly?? I have heard instances of where they wiped out the note in court and the holder who had bought the note lost everything trying to enforce it.

    Why residential over commercial notes or business notes, etc.?? Thanks for the insight.

  2. Hi Joel,

    Great questions! So are 2nd mortgages riskier than 1st mortgages? Now every investor’s risk tolerance is different, but I certainly don’t think they are. There are more perceived risks to 2nd mortgages and the market recognizes that, which is why 2nd mortgages are so much cheaper to buy. But for the price of one 1st mortgage I could buy eight to ten 2nd mortgages. Even if I only get out of 7 or 8 out of ten, doesn’t that diversify my risk? It’s less money in any one deal, so I would much rather have that then all my eggs in one basket (but again, that’s just my tolerance). Maybe to give you a more specific answer about risk, what do you think is riskier about 2nd mortgages Joel?

    Now do I make more money holding notes long term or flipping notes? We’re a velocity business – we buy the note wholesale, rehab the note, and flip it retail which is where most of our revenue comes from. But we also hold notes long term and we sell notes we don’t work on. We do all of the above.

    As far as the SAFE Act goes, it doesn’t effect us because we don’t originate. We also own the loans we modify, we’re not doing modifications as a business practice. The same goes for your question about notes that weren’t serviced or originated correctly. We only buy institutional notes directly from the banks, so that usually doesn’t happen because we have reps and warrants with the banks we buy from (and we see electronic versions of docs in advanced, plus we have a company that retrieves docs just in case).

    Why residential over commercial or business notes? Since our model is based on helping homeowners stay in their homes, we like residential owner occupied notes because the borrower is more emotionally attached to the property. This usually leads to a profitable workout which is where most of our revenue is generated. We are able to buy at a lower price point and through the workout generate a higher yield.
    Commercial and business notes are just different models, and honestly delinquent residential mortgages are just what I was introduced to first. I know commercial notes usually require more capital, plus commercial investors tend to be geographic buyers as opposed to us where we can buy all over the country. As for business notes, I’m not sure what assets you could attach (if any), but I do know that 90% businesses fail in the first 5 years. This makes me assume they’re more risky but again, I’m sure there’s a model that has perfected it.
    Does anyone here on BiggerPockets want to chime in on commercial or business notes?

    Great questions, keep ’em coming!
    – Dave

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