If someone were to approach you with a new deal, would you know what to do? What if you were suddenly to inherit a note? I guess the answer would really depend on you, your situation, and your overall level of experience.
This exact scenario just happened to two different people I know. One was actually a fellow BiggerPockets member, who was inquiring about what to do in this situation.
The other was the daughter of a note investor who passed away. Her mother, who I sold the note to, was pretty familiar with non-performing notes, but the daughter really didn’t have much experience at all. It was pretty easy to help her out since I had a lot more information on the note, and we were actually able to buy it back from her.
What Do You Have and What is it Worth?
As my partner Bob says, “You are where you are.” The note is only worth what the note is worth at a particular point in time.
If it’s a performing note, it’s relatively easy to determine the note’s value once you establish the type of lien(i.e. first liens, second liens, commercial liens, etc.), the pay history, the balance owed, interest rate, and payment amount.
Also, what’s the present value of the future money stream? Jimmy Napier’s book Invest in Debt is a good tool for learning how to determine this.
If it’s a nonperforming first lien, it’s pretty straightforward. The most common exits are through the property, so what you really need to know in order to make a decision is occupancy status, FMV (Fair Market Value of the property), UPB (Unpaid Principal Balance), and the status of any back taxes, liens, or encumbrances. For example, if the property has delinquent taxes and is headed towards a tax sale, this could jeopardize your investment if you aren’t monitoring it.
On the other hand, if it’s a nonperforming second lien, it’s a little more advanced. There’s more that you would need to get clear on in order to make a qualified decision.
How to Get Clear on Your Note Deal
First of all, you would need to get clear on the administrative part of managing the note, including documentation and accounting. It’s important to make sure you have all of the necessary documents in your collateral file. Typically, this includes the note, mortgage, assignments, and allonges.
There are also a few other considerations. For example, is your assignment recorded? If this is a note that you did inherit, do you have all the proper paperwork and titling in place to settle the estate, such as a short certificate? On the accounting side, you need at least the unpaid principal balance and the last payment date applied to calculate any type of billing statement or payoff.
Next, there are certain things you would want to monitor as the second lien holder in order to protect your positon, the biggest one being the senior lien status. Some of the other potential risks are left more for the senior lien to monitor, including municipal liens, homeowner associations, taxes, insurance, and any other liens.
Property & Borrower Status
Finally, you may want to get clear on both the status of the property and the borrower’s situation. In regard to the property, what is it, where is it, what’s it worth, and what condition is it in? Also, is the property vacant or is the borrower still occupying the premises?
With the borrower, mainly you want to know what their intent is. For example, do they want to stay in the property and possibly create a new payment plan, or would they rather move on from it? Is the homeowner underground, as in he/she will not respond or engage in a dialogue at all?
Once you’re as clear as possible on many of these things, it’s much easier to make an informed business decision.
Although with delinquent second mortgages the most common exits are through communication with the borrower (i.e. payment plan, short sale, discounted payoff, deed in lieu, seller assist, etc.), if you have little or no experience with non-performing notes, things could become quite difficult.
That being said, here are a few options people consider:
- You could hire a licensed servicer, who also has a specialty servicing capability. In other words, they’ll legally collect on a delinquent asset in a compliant manner. (For example, companies like Madison Management or FCI provide these types of services.)
- Some folks hire or partner with someone who is familiar with collecting on nonperforming second liens. (FYI, there are people on Bigger Pockets who do this.)
- Others may have their attorney provide any legal services or new work out agreements with the borrower.
Of course, I’m not trying to give out legal or accounting advice nor am I telling anyone what to do. These are just some of the options available. Personally, I’d lean towards utilizing the licensed servicer in this heavily regulated environment.
So, if I were to inherit a note and I didn’t know what to do, one option would be to keep the note, follow the legal process, and hopefully come to an agreement with the homeowner. If an agreement is not possible, there’s also the option to foreclose and rent it out, recouping whatever you can or keeping it as a rental until you can sell it.
Another option is to just sell the note. Some folks market notes on places like LinkedIn groups, Facebook groups, Auction.com, Note MLS, eBay, FCI exchange, and more. It may pay you to research some of these sites to see what assets are selling for, and don’t be afraid to ask around. After all, a note deal will only take place if there’s a motivated buyer and seller.
So, would you know what kind of deal you had if a note came your way?
Be sure to leave a comment below!