How to choose a profitable mortgage note

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In todays email:

  • 🤓 Deep dive: The due diligence process for acquiring distressed assets (i.e. non-performing notes).

  • ❓️ Your questions, my answers: I answer questions from newsletter subscribers like you.

Deep Dive

Distressed Assets: How to decide which non-performing notes to buy.

When trying to decide which non-performing mortgage note(s) to purchase you have to take many factors into consideration. There are several steps to narrow down the list and decide which notes will be best to meet your criteria. Everyone has different preferences/criteria such as certain states, notes with equity, notes with no equity, vacant property vs occupied property, risk tolerance, etc.

In this newsletter, I would like to go through how I narrow the field, then discuss what are the steps that I take to determine whether it is a note that fits my criteria and tell you what my criteria is which may be different than yours.

Determining which mortgage note is a good investment involves a thorough evaluation of various factors and knowing your risk tolerance, main exit strategy, funds available, timeline, etc. Here are many things to consider when assessing whether a particular mortgage note is right for you.

  1. Research the market and the foreclosure laws for the location(s) you are looking to buy. Gain an understanding of the social and economic conditions that may impact the value of mortgage notes like how good are the schools, crime rate, rent rates, property tax rates, neighborhood types, etc. Just like buying real estate, buying notes is all about location, location, location. Now that being said, I have bought notes in not so great neighborhoods and made good money but you have to price the note accordingly to offset these risk factors. In addition, you have to know the foreclosure laws in that state. Certain states have a very long and costly foreclosure process (NY, NJ, etc.) and some states have a short and less costly foreclosure process (TX, GA, VA, etc.). I buy notes in long foreclosure states as well as short foreclosure states knowing I have to price in the legal costs and time frame to resolution into my bid (or you will lose money).

  2. Define your investment goals. Clarify your investment objectives and risk tolerance. Determine whether you're seeking a short-term or long-term investment, and the level of risk you're comfortable with. For example, if you are looking for cash flow then you should look for notes that are owner occupied and possibly doing some sort of loan workout and get the borrower repaying. If you are just looking to get the house to fix/flip then a vacant property would be better.

  3. Evaluate the key features of the mortgage note, such as the principal amount due, total payoff, interest rate, remaining term, payment history, and any other relevant details.

  4. Analyze the underlying property securing the mortgage note. Factors to consider include the location, condition, market value, and potential for future appreciation. A property BPO (brokers price opinion) or inspection (if vacant) might be necessary. Ask a local agent what houses are selling for in the area and ask them to take exterior pictures of the property and their impression of condition.

  5. Calculate the Loan-to-Value (LTV) Ratio. Determine the LTV ratio, which represents the loan amount relative to the property's value. Lower LTV ratios generally indicate a lower risk. In addition, you will want to know your Investment-to-Value (ITV) especially when buying the note at a discount.

  6. Review the note's documentation. Carefully examine the mortgage (or deed of trust) and promissory note. Also examine the supporting documents, such as the assignments, allonges (endoresements) and any associated legal paperwork. Ensure all necessary documentation is in order. Super important! If you do not have the correct docs then you will not be able to foreclose if necessary. For example, many states require the original “wet ink” promissory note in order to start the foreclosure process.

  7. It is a good idea (especially if new to the process of buying notes) to conduct a comprehensive due diligence process that may involve engaging professionals like creditor attorneys, mortgage servicing experts, and title companies. They can help verify the note's authenticity, identify potential legal or compliance issues, and assess the overall investment viability.

  8. You need to do the math. You must assess the potential cash flow and/or returns based on your exit strategy. Look at the various exit strategies, such as holding the note until maturity after you get the note re-performing, selling the note in the secondary market, or exploring options for renting or owner financing the property if you get the property back as an REO. You have to determine what your cash flow would be if you got the note re-performing and compare these returns with your investment goals and expectations. What if you could not get the note re-performing and had to foreclose..would you make money?

STEPS TO NARROW DOWN THE LIST OF NOTES TO BUY:

When buying non-performing notes, may note sellers will send you a “tape” of notes for sell in an excel spreadsheet. Here are some steps to narrow down the list to a manageable level.

  1. Eliminate states you do not desire to buy notes in.

  2. Sort by property type. I prefer single family residential (SFR) including townhouses and condos.

  3. Sort by occupied and vacant. Your focus should be on occupied properties if you want to exit through the homeowner (loan mod, workout, etc) or you can focus on vacant properties if your exit is through the property (deed-in-lieu, foreclosure, etc.).

  4. Filter out houses built before 1950 or whatever your criteria is.

  5. Filter by value range. Example - Low: $70,000 High: $400,000. This will depend on the amount of capital you have to work with.

  6. Filter by LTV (loan-to-value). I don’t care if over leveraged. I look at all LTVs. Just remember that when looking at properties with alot of equity the note seller will not sell at a big discount.

  7. Sort and eliminate low PI payments. I remove all assets with PI payments below $400. Again, this is my personal preference. Many investors love these especially when limited funds to work with.

Now that the list is narrowed down a bit, these are the next steps for the due diligence process.

  1. Run a quick search in Google maps for the property. You are looking at the neighborhood, the condition of the houses, how well people maintain their property in that neighborhood, etc. I want to be in areas where people maintain their property, cut the grass, and generally have a sense of pride of homeownership.

  2. Try to get a ballpark number on the property value using Zillow. This is the first pass on the value (not the final value) but many times it is good enough especially when there is sufficient equity. You will get more granular in the valuation process once you have narrowed down the notes of interest.

  3. Research the rents in the area (see prior newsletter on how to research rents). Why? Because I want to determine if I get the house back am I able to rent it and still make a decent return.

  4. For vacant properties, I focus on the Investment-to-Value (ITV) being at a certain percent. In other words, I'm looking at my note purchase price divided by the value of the property and this number should be less than 70% depending on the amount of work the house needs. I'd like to be 65% or less in most cases but may pay more or less depending on the amount of rehab. In addition, I need the investment to balance (ITB) to be less than 80% so that if it goes to auction and sold to a third-party I can make some money. For example, if the UPB (unpaid principal balance) is $200,000 and I am buying at $160,000 then I can make up to $40,000 at auction if the property value is north of $200,000.

  5. For occupied properties, I will also look at the ITV and the ITB but in addition I need to make sure if the note becomes re-performing that I can make an IRR that is in the double digits. I don't want to buy a note where I may be buying at a good ITV and ITB but I'm only making 4% on my money and now I have to hold it for 30 years.

  6. Now that the list is narrowed down, I will make indicative bids on those notes and try to come up with an agreement with the seller. Once we agree upon price, then I will run a title search to determine the liens on the property, taxes due, code enforcement issues, etc. I will also request the due diligence documents for review such as the mortgage, note, allonges/endorsements, assignments, etc.

The steps outline here are not all inclusive but rather the big picture view of the process. There are many smaller steps that need to be done in order to buy a non-performing mortgage note. Many of the same steps are used for performing notes as well. Once everything is agreed-upon you would sign a note sale agreement (NSA) which needs to be reviewed in detail before proceeding since every seller has different language in the NSA. See prior newsletter about what information is contained in the NSA.

Your Questions, My Answers

In this new section of the newsletter, I will answer many of the questions that I have been receiving from subscribers like you. SO PLEASE SEND ME YOUR QUESTIONS and I will answer those questions in upcoming newsletters (on a first come, first serve basis). I will answer 1-3 questions each newsletter depending on the complexity of the answer.

🖐️ IF YOU HAVE A QUESTION, PLEASE RAISE YOUR HAND AND ASK BY SIMPLY REPLYING TO THIS EMAIL.

Last weeks POP QUIZ was…What is a “request for notice”?

ANSWER: This request (recorded at the county courthouse) is usually made by an individual or organization receive notifications or updates regarding certain legal proceedings or actions taking place for a particular property. It ensures that the requester stays informed about any developments or changes related to the specified matter. For example, if you are a second mortgage owner, the “request for notice” ensures that you receive updates, notifications, or any relevant information pertaining to that property such as potential foreclosure proceedings.

This weeks POP QUIZ: What is quiet title?

Check out next weeks newsletter for the complete answer.

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