Performing and Non-performing Notes

Over 60 per cent of Americans own a home. A great majority of these homeowners bought their homes with loans from the banks and other financial institutions. When you get outside the realm of residential real estate and consider everything out there that is being financed then you are talking about trillions of dollars that are borrowed by buyers. Everything from a mobile home to a condo, townhouse, single family residence, multifamily residence all the way to commercial properties such as huge apartment complexes to gas stations and strip malls can carry a loan on it.

The person who originates a loan does not necessarily have to be the one who owns it. They may simply be a loan originator brokering the loan, or note, for the real money owner the investor. There are a whole lot of loan brokerage firms out there who specialize solely in originating notes for investors. If you have ever bought anything that was not fully paid for in cash at the time of purchase then you most likely encountered a situation where the loan originator asked you to fill out an application, ran your credit and qualified you for the loan. That person most likely acted on behalf of an investor, who could be a wealthy individual or an institution.

The investor may decide to keep (i.e. portfolio) the note himself and have you make payments directly to him. The institution may do the same. He may hire a note servicer to whom you make your monthly payments. That servicer may well be the loan originator. For instance, when you walk into a Bank of America branch and meet a loan officer who originates a mortgage for you, you may think that Bank of America is the note holder and you will be sending your payments to them. However, in actuality, your note may have been originated by Bank of America on behalf of an investor. That s why people get ever so confused in short sale situations whereby the negotiator at the bank tells them that the investor has turned down their request for a short sale or loan modification.

As you know, no bank can survive on its own without the deposits from its members. Banks use those deposits to lend money to borrowers. In fact, no bank can continue in business without a healthy influx of deposits from ordinary people like you and I. To remain solvent and healthy they must continue to lure customers and they d prefer if their customers would keep their money with them for long periods of time. Ever wondered why they give you better returns, like in a CD, if you keep your money with them for longer? They want predictability, which is a good and smart thing to do.

Ever heard of such a thing as the secondary market? That s a hot place. Billions, even trillions, of dollars are traded daily in the secondary market. Brokers and banks sell pools of notes everyday to buyers in the secondary market. These loan originators make their money by charging points (i.e. upfront fees) to the borrowers and/or getting rebates from the buyers of these notes. You can make money, BIG money, by becoming a loan broker, which is fine. In fact, loan officers and their bosses made a boatload of money during the days when just about anyone who had breath in him and had good credit would be given a loan. In those days, loans were given to borrowers with no income and no assets. The brokers would charge an arm and a leg in points and also get rebates. Those crazy days are over but there is still room for those brokers who survived the crash and new people to make money, I mean good money, originating loans.

Perhaps being a loan agent is not your cup of tea, but you d like to know how to make money by way of buying performing and non performing notes.

There are pools of notes that are being sold daily. Performing notes are notes where the borrower is current on his payment and has not missed a single payment or at least has become current. A non-performing note, on the other hand, is a loan on which the borrower is not making payments, i.e. has become delinquent.  You will find that the cost of a performing note may be higher than that of a non-performing note, for obvious reasons. The performing note is a good loan. The borrower is strong and can be relied on. Good things cost more than bad things. But what is perceived as bad can be a blessing in disguise. The owner of the non-performing is a distressed note holder dealing with a distressed borrower. It costs the distressed note holder money to place those collection calls, to hire an attorney, etc. As a result, he may be more than inclined to sell you the note at a substantial discount. When that happens, you then become the lender and can do whatever the law may allow you to do with the distressed asset. You may decide to foreclose on it and resell it for a substantial profit.

These things are being done every business day. I have an attorney friend in the Los Angeles area who specializes in buying non performing seconds from financial institutions. He sends agents to do BPOs (Broker Price Opinions) on the target assets and makes his decision as to how much to buy the notes for based on the BPOs. Buying second mortgages can put him in a very enviable position.  Very often he can create instant equity in the asset he is buying. Let s say the borrower owed $1,000,000 on a house on a house that is upside down and is worth only $950,000. The borrower owes $800,000 to the first lender and $200,000 to the second. Bad things happen in life. The borrower may have lost his job, his health, his spouse or his business or because of the loss in value he may strategically choose to default. He may tactically stop making payments on the second mortgage. He knows that the second lender is in a delicate position. Months go by and he does not pay a dime to the second lender. The lender makes collection calls daily but Mr. Chu doesn t budge. This lender will have to foreclose on Mr. Chu in order to recuperate his investment. However, to do so may spell more disaster to the lender. If this lender forecloses on Mr. Chu he will inherit the first note, which is $800,000. Doing so would make absolutely no sense. So, this lender is in a tight situation, perhaps even more distressed than the borrower. Collection activity and attorney fees, if any, only serve to compound an already bad situation for the lender. He must do something to stop the bleeding and his best bet may be an offer from a note buyer.  The lender may get as low as 10% of even less from the note buyer. In fact, that s way better than because it could be worse. If the first lender forecloses on the first note, there is no recourse for the second. The second would lose everything.

See the beauty in making money as a note buyer? Let s go back to the example above.  The note buyer gives the second lender 10% of what the lender is owed. That s only $20,000. Remember, I said that the property is worth $950,000. All of a sudden, the asset that was over encumbered is no longer upside down in value. Now the total note amount on the house is only $820,000. The note buyer has created instant equity. He can now either negotiate with the borrower and if the borrower meets his terms and conditions he may decide to keep the borrower. Conversely, he may decide to sell the home FAST and make a quick $80,000 to $100,000. Can you imagine that? The guy spends $20,000 yet makes four times that amount.

How people do you know who allowed their precious homes to go into foreclosure even though they had equity in their homes? They missed a payment, then 2, 3, 4 and the lenders decided to foreclose on them. Now, can you imagine how much money you d make if you sort out these people and sought to rescue them from their despair? There are investors out there who only business is seeking out distressed owners with equity in their homes. This is a win-win-win for all players. The homeowner does not get foreclosed on. Instead she walks away from money in her pocket when the investor steps in and either makes current what is delinquent or totally eliminates it.

Back in August 2010 a couple whom I knew as friends called me and told me that Wachovia had sent them a letter allowing them to short sell their home. They had bought the home back in 2000 in the $300,000 range. They were the original owners. Through the years, they had refinanced the home and at the time owed over $560,000 for it. Those were the days. As you know, home values plummeted very badly in California and especially in Central Valley where this home is located. Wachovia recommended they find a realtor to sell the home for $198,000. They had tried modifying the loan. However, because of their low income it made absolutely no sense to modify their loan and keep them in the house. It d been more than 2 years that they had not made a single mortgage payment. The bank was in a dire situation and wanted out. This couple called me to help them sell the house.

What do you intend to do after the home is sold? I asked.

Well, our plan is to relocate to the Bay Area and rent an apartment in Hayward, he responded.

Is that really what you would like to do?

What are our alternatives?

What if we could find a solution of keeping you in the home? Certainly, you have taken great care of the home. You d love to stay here, wouldn t you?

Of course, we would, responded the husband, his eyes dilated.

The wife had suffered from cancer but had fully recovered. She was actively looking for work and it d take just a few months before she lands a good job as a chemist. So it made good business sense to help them.

I offered to buy the house from Wachovia and Dyke O Neal, the second lender. Wachovia stressed that if they did not get their funds by 3 p.m. that Friday in August they d foreclose on the house the following Monday. I remember instructing my assistant to work with my private money lenders to wire the funds to both lenders immediately. I was thousands of miles away in Washington DC. My assistant and my private money lenders were back in the Bay Area. They went out of their way to make this happen and eventually the house was saved from foreclosure. I now became the note and deed holder and payments were made to me monthly until such a time the couple was able to buy the house back. I rescued them from despair, gave them hope and made money in the process as well.

I could quote instance after instance allow me to leave you with the process: