A week or so ago, a colleague of mine from BiggerPockets reached out and made the valuable suggestion that I write an article, specifically, on arrears. When note investing, especially with delinquent assets, you will run into the question of how to collect arrears.
Notice I said collect. When investing in performing notes and mortgages, we think more of passive investing where there’s usually little interaction, if any, with the borrower. But with nonperforming notes, collections are a more prominent factor. Your ability to contact and negotiate with the borrower really determines how successful and profitable you’ll be in the business.
So What Exactly Are Arrears, and What Do They Consist Of?
Arrears are the overdue debt not including UPB (Unpaid Principal Balance), such as any missed payments, late fees, or corporate advances. Corporate advances can consist of any money spent towards legal, any other costs that are spent in order to collect, or any money spent in order to protect one’s interest as a lien holder. A few good examples of are tax payments, homeowners insurance, condominium or homeowner association fees, or any other reinstatement fees paid to a more senior lien, etc.
But, How Do You Approach Arrears When Dealing With a Homeowner?
Once you do make contact with the homeowner(s) and they let you know their intention (and it is to stay in the home), now the focus becomes affordability. We use our Homeowner Financial form to go over their income and expenses, as well as their assets and liabilities, to determine how much money they have available and how much they can put towards a monthly payment. At this time, we try to determine what disposable income, or capital, if any, is left to be put towards their arrears.
Oftentimes, a homeowner will say, “I can afford to make $___towards payments,” but they don’t include their overdue balance (or arrears) in this statement. The asset manager may respond, “That’s great that you want to address the debt by making payments, but that’s only half of the solution. Management will want to see something paid towards missed payments.”
It is very important to try to collect as much towards arrears as possible because this will allow the delinquent note owner to take as much of the risk as possible off the table. One way to potentially increase the amount of arrears that’s collected, or increase the odds of receiving a discounted payoff, is to give the homeowner incentive by making it worth it for them to do so. This could include offering more favorable terms like a lower interest rate, a lower pay off, or different term lengths.
The focus should be—what’s the most important to the homeowner- and, all of these would be based on the premise that the more money that’s put towards arrears, the more we can do for the homeowner. Asset managers may mention how other borrowers were able to access funds to put towards their arrears—everything from borrowing from a 401(k), borrowing from family and friends, borrowing from a life insurance policy, or even utilizing an income tax check. Only in an extremely rare case are we not able to collect anything at all towards arrears. It’s very unusual that someone can’t come up with at least $500-$1000 when they haven’t made a payment on their home’s mortgage in years.
It Really Comes Down to Three Things:
What can they afford? How hard are they trying? And, can they prove it?
If the homeowner makes a solid effort in each of these categories, we will bend over backwards to help them, even if it means not collecting any arrears at all. If this is the case, we may revisit their situation in six or 12 months to see if anything else has changed, where they may now be able to afford something towards arrears (February, March, and April are the best months to collect arrears due to tax returns).
This is a Trust and Verify type of situation, and we will often require documentation (tax returns, pay stubs, checking account statements, etc.) to back up all of the financial information they’ve provided. After all, a bank would request similar information if they were doing a loan modification as well.
So, the level of arrears that you collect will really depend on how persistent, creative, and skilled you are when dealing with the homeowner. Arrears have been a very profitable and consistent source of revenue for my organization. And, they can be for yours as well.
Photo Credit: JD Hancock