Non-performing notes and non-performing loans are terms used interchangeably.
When a lender makes a loan on real estate the documents include the note (promissory note), the mortgage or deed of trust, and where applicable the allonge. Allonge is a fancy way of saying the attachments from the French, “it’s a slip of paper attached to a negotiable instrument” – Wikipedia.
When you “buy the note” you are buying all of the rights (and responsibilities) of the lender. You become the bank.
Other terms for non-performing notes are:
- Non-performing loans
- NPLs
- NPNs
- Distressed loans
- Distressed notes
But the most common vernacular is simply “notes” or non-performing notes.
There are a variety of workout options to turn around a non-performing note.
Reinstate the loan
This is an ideal but typically most unlikely outcome of our discussions with borrowers in default. If they have been unable or unwilling to make their regular payments the last 3 years, it is highly unlikely they will just start now because you ask them to. Usually a life event has occurred in the family (divorce, medical issues, trouble with the law) or in the workplace (loss of job, disability) which has cause severe financial hardship. We are not usually the only creditors that are calling and sending letters to collect debts. It’s a scary and frustrating time for borrowers – and without some help and compassion, they are unlikely to be able to resume their regular payments without a loan modification, described below.
– Modification of loan terms (known as a forbearance agreement)
– Loan Assumption (someone else takes over payments, such as a family member)
Short sale
If an investor buys a note and the borrower wants out of the house, a short sale may be the best option. If the non-performing loan is the only loan on the house, then the investor has complete control over the short sale process. He can approve or deny any offer since he is essentially the bank now. Due to the low cost of the note, the investor should be able to make a nice profit even after paying real estate agents and closing costs. If there were other loans on the property, then you would have to negotiate with those lien holders. It becomes much more complicated, but it is possible. Here is an article that explains the short sale process.
Deed in Lieu of Foreclosure
A Deed in Lieu is when the borrower signs over their rights in the home to the note holder. These can be tricky if there are other liens against the property. It is best to let the servicer work out all the details to make sure you get a clear title to the home. Many banks try to get a Deed in Lieu because it is much less expensive and less involved than a foreclosure.
Cash payoff (borrower pays off the note, potentially at a reduced amount)
Foreclosure (the last resort)
A book written by a highly regarded note investor often repeated the mantra, ” We are in the business of giving people second chances, but not third chances.” We strive to create agreements with borrowers that they can keep and be happy about. Sometimes a borrower just refuses to work with us or does not live up to their end of the agreement. If we’ve exhausted all options and the borrower has blown their second chance, foreclosure might be the only option. If you are considering buying non-performing loans, always calculate profits based on the worst-case scenario, which may be foreclosure. In states with easy to complete foreclosure processes, the foreclosure costs can be $5,000 to $7,500 on a low value property. In states with a longer foreclosure process, the costs can be much higher.
The nice thing about foreclosure is, once the process is complete the investor owns the home and has complete control over it. The investor can rent the home, sell it as is, fix it up, or even price it low enough at the foreclosure auction that another investor will buy it. One very important thing to keep in mind with a foreclosure is the state laws where the property is located. In some states, you can foreclose in 45 days or less, in other states it can take over two years to foreclose. It all depends on whether the state is a judicial or non-judicial foreclosure state.
Depending upon the borrower’s preferences and actions, either payments start being made again, the property is sold, or the property comes back to IEC Ventures as an REO (Real Estate Owned). As shown below, there are various exit strategies at our disposal. IEC Ventures carefully chooses the best exit strategy to maximize the ROI (return on investment), and meet the needs of the Joint Venture partner if applicable. Note that we only purchase assets where multiple exit strategies are forecast to result in above-average ROI.
Exit Strategies:
– After receiving 10 – 12 month of on-time payments, sell the note as a re-performing asset
– Sell the home to a retail buyer or real estate investor
– Put a tenant in the home, and after 6 months sell the asset as a turn-key rental property
– Keep the note for long term cash flow
– Put a tenant in the home, and retain the property for long term cash flow