NPN Story: What Easy Looks Like
Not every note we buy involves a huge amount of drama. Not every note involves a deadbeat borrower who will do everything in their power to stay in their house as long as possible without paying a dime. Not every borrower files for bankruptcy to stop a sale. Some borrowers, for one of a number of reasons, decides not to fight and let’s things just happen. This is what it looks like when it’s easy.
At the beginning of 2016, we bought a note for a house in Palmdale, California. This one had a lot of equity, which affected how much we were willing to bid. The Total Debt was about $110,000 and the property was worth $200k.
Underwater or Equity?
When a non-performing note is underwater i.e. where the loan balance exceeds the value of the property, you base your bid off the value of the property. When the loan balance is 80–85% of the property’s value, then there’s enough equity coverage to ensure that you’ll be able to collect that entire balance so you make your bid as a percentage of the Unpaid Principal Balance (“UPB”) instead of the property value.
As a lender, we are only entitled to collect the total amount of debt owed to us. We are not entitled to the equity over and beyond that. Any excess proceeds go to junior lien holders until those debts are satisfied and anything over that goes to the owner/borrower.
For example: If the UPB of a loan is $200,000 and the property is worth $100,000, then you’ll base your bid off of $100,000. Each market is different but, generally, your bid would be 50–85% of $100,000 (or $50,000 to $85,000).
However, if the UPB was $200,000 and the property was worth $400,000, you will collect 100% of what’s owed on the loan because of the huge equity cushion. It’s considered a lot less risky than the underwater loan where there’s a lot more uncertainty on what you’ll actually be able to collect. This type of loan where there’s equity will sell for 80–92% of UPB.
For our Palmdale loan, nothing looked unusual. I could see in the title report that the property was Quitclaimed to the borrower a decade prior. He took cash out by taking out the loan, which we were looking to buy. He was about a year late on his payments.
Quitclaim Deeds to Family or Friend, Refinance, Default Pattern
Note: This is a pattern that I see over and over again. Quitclaim Deeds are typically used in non-arms length transactions, such as those between family and friends, and from individuals to trusts or other entities.
Families transfer a property to a financially lesser off relative who takes cash out by getting a loan. I assume that the poorer relative was in that situation in the first place because they weren’t good at handling their finances. Their habits haven’t changed as they get themselves into trouble by not paying on the new loan because they run out of money.
The foreclosure process had already started and there were only a couple of months to go by the time the loan transferred to our servicer. The borrower was unresponsive to our servicer’s attempts to reach him.
The Easy Part
We almost forgot about this loan because there was absolutely no drama and we were busy dealing with the other loans. The property was sold to a third party bidder at the trustee sale for $160,000.
An investor bought a $200,000 house for $160,000. We collected the entire debt of $112,937, which was more than what we paid for the loan. We sent a few e-mails and made a phone call or two but this loan took the least amount of work and was the least stressful by far.
The owner/borrower got to collect the difference between $160,000 (what it sold for) and the $112,937 that he owed without lifting a finger or doing anything. Is it possible that he could have made more by selling the property with a realtor before the foreclosure? Most probably, yes. For one reason or another, he wasn’t willing to make that effort and was willing to accept less for no effort.
Things I learned:
– Not every loan needs to be a home run or will take a lot of work. I’ll take “singles” like this one with little effort all day long!
Things for Newer note Investors:
– You base your bids off of the property value when the loan is underwater. You base your bid off of UPB when there is equity.
– You can only collect up to the Total Collectible Debt on the loan. Anything beyond that goes to junior lienholders until they are made whole. Anything beyond that goes to the former owner. Any senior liens are not affected by a junior lien’s foreclosure.
Purchase Price: $85,000
Total Cost Basis: $85,327
Net Sales Price: $112,937
Net Profit: $27,700
Days Held: 87
Return on Investment (ROI): 32.9%
Annualized ROI: 229.4%