How to Determine the Quality of the Paper Investments You’re Buying

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You’ve probably heard the saying, “There’s different strokes for different folks,” and when it comes to note investing, that saying certainly holds true. There are so many different niches in the note business, and note investors/buyers have varying levels of risk tolerance.

For example, there are seller-financed notes, hard money deals, secured first and second mortgages, commercial deals, and even unsecured debt.

So, just as there are so many different types of debt, there are just as many variations in the corresponding paper or collateral files.

Your collateral file is a huge factor for determining the value of the note. The quality of the collateral has just as much if not more of an impact on the value of the asset as equity, lien status, property condition, occupancy, etc.

That being said, you’re not always going to go down the legal path. If other exit strategies (such as a loan modification, discounted pay off, reinstatement, short sale, etc.) don’t work out, you do want to make sure you’re prepared for the worst case scenario.

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Ability to Foreclose

When it comes to secured mortgages, which usually means that there’s a piece of property or real estate backing the loan, at the bare minimum, it really comes down to your ability to foreclose.

From a document management perspective, do you have all the documents in the corresponding collateral file to start and complete a foreclosure if the need were to arise?

State Requirements

Some folks, especially those who invest in performing notes or who are in the seller-financed world, often require pristine paper in order to be able to get top dollar for the note. They want all types of things to be included in the files besides just a note, a mortgage, assignments, and allonges. They like to see things like the original loan application, the title policy, and homeowner’s insurance declaration pages.

Related: Diversifying into Real Estate Notes? Better Choose a Strategy! Here’s How.

When it comes to distressed debt (like non-performing mortgages), it would be nice to get all these things in the collateral file, but oftentimes that’s just not the case. With second mortgages, that may not even be possible.

So, how do you determine what really needs to be in the file?

Since it’s very state specific, it may make sense to ask your foreclosure attorney in advance what’s required in the state where the loan you’re buying was originated. Some states want you to send the original note to your attorney so that it can be provided in court.

At this time, in the majority of the states, if you do not have the original note, a lost note affidavit may be accepted. However, needing a lost note affidavit is a very rare occurrence.

I don’t ever remember needing the original loan application, insurance policy, or title policy. Sure, a title policy may be helpful during a title claim, but these can usually be obtained through a document retrieval company.

As for homeowner insurance, the policy usually states to have the named insured followed by the words “and/or assigns” to include any future note purchasers.

So, it’s very important to know what is really needed and what is not. This is what creates the opportunity to either be successful with a foreclosure or to increase the value of the note by completing the collateral file.

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Related: What Investors Should Know About the Tax Implications of Investing in Notes

Reps and Warrants

Some note sellers honor reps and warrants to protect the note buyer/investor against incomplete collateral files. For example, most Loan Sale Agreements have buyback provisions with specified timelines. These are designed so that you may require the note seller to buy back an asset, either because you were missing critical collateral or in cases where you never received it to begin with.

So, as a policy, it makes good sense for you or your document management company/department to do a full inventory of the collateral documents at the time of purchase for all of the assets you buy.

So, let me ask you — how do you determine the quality of the paper you’re buying?

Leave your comments below!

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.

8 Comments

  1. Dave after playing in the note space a bit and I say playing because that is really what we have done with so few notes I have found that where you buy your notes also helps with having better paper. We have purchased from a great group of people, but their files were very slim pick ‘ens and then we have purchased from PPR and had a very clean and somewhat complete file . . . looking forward to seeing you in Kansas City Next week!

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