As the real estate market slow down continues, and with foreclosures on the rise in most of the country, lenders are finding themselves overwhelmed with many sub-performing and non-performing loans.
Many lenders are willing to consider a “short sale” where the lender will accept something far less than what is actually owed to them. However, actually owning the debt instrument itself (the promissory note) may be more useful for the savvy investor.
So, what are “sub-performing” and “non-performing” loans?
Often called a “high maintenance” account–that is an account that requires a tremendous amount collection effort in order to reason, cajole, harangue, and beseech the tardy borrowers to make their payments month in and month out.
In some cases there may be rolling late payments, back payments already added to the outstanding principal, or an existing forbearance agreement between the lender and the borrowers to stave off a foreclosure.
These are accounts where attempts to collect have been unsuccessful and the account is simply not paying at all. It is in arrears with back payments and other expenses due.
Often, lenders in need of cash liquidity are willing to steeply discount the amount they will accept for the sale of their sub-performing or non-performing loan accounts (the promissory notes). These problematic accounts are a drain for the lender both monetarily and from a human resources standpoint.
For astute real estate investors, opportunities can be created by acquiring these secured loans, which can then be “scrubbed” up and become performing again or simply foreclose and repossess the collateral securing the loan. Lenders sell these notes to create liquidity and get these loans off their books.
Ten Simple Steps Involved in Buying Bank Notes
The mechanics surrounding the purchase of ANY real estate secured debt instrument (the note) are essentially the same whether you are purchasing from a private note holder or from a bank-type lender.
Here are ten steps to follow:
- Verify the outstanding balance due on the note and the actual repayment terms of the note. I cannot stress enough that you MUST review the actual documents that were executed!
- Verify with the seller of the note (the Assignor) the interest paid through date (or last paid date).Also verify the next payment due date
- Ascertain that the mortgage (or trust deed) is an insurable FIRST lien position loan (assuming you are buying a 1st lien). This is where a review of the existing mortgagee/lenders title insurance policy comes into play. Such a loan title insurance policy was probably issued when the loan was originated.
- You also want to establish the status of the property taxes, whether they are current or delinquent, and any impound escrow funds that might be held and be transferred to you for such payment as taxes and fire hazard insurance premiums.
- Confirm the value of the collateral property that secures the note (that is today's fair market value). You can do your own evaluation, or have a BPO (broker price opinion) report done, or a formal drive-by, exterior only appraisal, etc.
- Get the actual mortgage (or trust deed) security instrument assigned over to you or your entity. The assignment, once executed and recorded, will accomplish this and transfer all rights, title, and interest in the instrument to you; the assignee.
- Have the original promissory note instrument endorsed over to your or your entity (making sure the assignment of the security instrument and endorsement of the note match one another). The endorsement can take place right on the actual original promissory note instrument or via a separate note allonge; an attached endorsement).
- Have physical possession of the original promissory note instrument given to you. This is the negotiable instrument you are purchasing and whose rights you will be able to enforce for non-payment of the debt.
- You may want to obtain an estoppel affidavit from the Assignor. They will affirm for you the actual balance and terms of the note and might be useful in a later dispute with the debtor.
- Obtain notification letters to both the note payor and fire hazard insurance agent notifying them of the transfer of the note account. (These are often referred to as so called “goodbye,” “welcome,” and change of loss payee letters).
It would be wise to further consult with your own attorney to make sure that what you are purchasing is what you bargained for. Once you own the actual debt instrument (the note) there are a number of options available for you to pursue in an attempt to collect or get the note instrument performing. Some of these options will be covered in a future article.