How to Invest in Non Performing Loans or Notes
Buying non performing loans or non performing notes is a great way to invest in real estate. Non performing loans are loans that the borrower has stopped making payments on or the borrower is behind on payments. In the past banks would foreclosure on these loans and sell the property attached to the loan, but now banks are selling these notes without foreclosing.
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Since the notes are non performing, the loans can usually be purchased at a large discount. After a NPL is purchased there are many avenues an investor can take to profit on the loan from loan modification to foreclosure. I have never purchased NPLs myself, but I am considering it as a way to buy more homes that I can either fix and flip or hold long-term.
To get more information on my investing strategy, check out my complete guide to purchasing long-term rental properties.
History of non performing loans or notes
In the past, most non performing loans were serviced by the bank who owned the loan. The bank would do their best to get the borrower to make payments on the loan by offering loan modifications, allowing a short sale or in the worst case scenario they would foreclose and take over the property. In today’s market many banks are no longer servicing their NPLs, they are selling them to investors.
When the banks want to get rid of their NPLs they will package up a large pool of NPLs and sell them off to the highest bidder. The companies that buy these pools are usually banks, servicers or hedge funds. Many of the hedge funds, banks and servicers will then attempt loan mods, short sales or go through foreclosure. It is very difficult for an individual investor to buy NPLs from banks, because they are sold as large pools of loans spread out across the country and cost hundreds of millions of dollars. However, there are more companies breaking apart the pools of NPLs and selling them to individual investors.
How can an individual investor purchase non performing notes?
There are a few hedge funds who are purchasing large pools of notes and then selling the notes off individually to investors. There are many companies that purchase large pools and either auction of the notes to the highest bidder or list them for sale like you would a home. Many note companies can be found online and sell individual loans or small packages.
What are you buying with non performing loans?
What you get with a note will depend on what type of loan you are buying and the company selling it. Some companies sell a note with title insurance, which guarantees the note is in first position. Some companies even include a BPO (broker price opinion) value from a third-party, which gives you an idea of the value of the home the loan is against. In some cases you may be buying second position notes, which are much less valuable than a first position note. A second position note must pay off the first note to gain possession of a property and could also be wiped out in foreclosure.
When you buy notes, the house that the note is against may have unpaid liens. The house could have unpaid taxes, city liens or judgments against the home. It is very important to do a lot of research on any note you buy to make sure you are getting what you think you are getting!
Why would investors buy NPLs?
Most of us have seen REO inventory decrease and prices increase in our local markets. It has been harder and harder to find good deals to invest in and NPLs offer an alternative to what is available on MLS. Some notes can be bought at 50 cents on the dollar or less. Buying on 50 cents on the dollar does not guarantee a good investment, but if you can buy a note cheap enough you may be able to get a very high return on your investment.
There are many different ways to make money with non performing notes and in some cases you may even end up with a very cheap rental property.
Servicing non performing notes
Once an investor purchases non performing loans, they have to decide how to make money on the note. The borrower is not making payments and they may or may not be living in the home anymore. There are many options to pursue with these notes, all of which can be very profitable. Since the investor owns the note, they can be very flexible working with the homeowner to help them stay in the home or allow a short sale.
Most real estate investors have no idea how to complete a loan modification, allow a short sale or foreclose on a home. Luckily there are many servicing companies who can help with short sales, foreclosures and loan mods. They also make sure the investors have all the proper paperwork and licensing when purchasing the notes. As the owner of the note, the investor can pursue any course of action allowed in the Deed of Trust for the property. Some investors may work diligently to keep a homeowner in the house and other investors will foreclosure to take possession.
How to make money off non performing loans?
Loan modification and refinance
Assuming you are able to buy a note there are many ways to make money on that note. Lets assume you buy a note for $50,000 on a house worth $100,000. The people still live in the home and want to stay, but can’t afford the payments on the $150,000 loan they took out five years ago. They know the house is worth $100,000 and are fine with a loan of $100,000 at 5% interest. The investor who owns the note modifies the balance to be $100,000 (still $50,000 over what the note was purchased for) and lowers the payments to something the homeowners can afford.
Once the homeowners make three months worth of payments, they are now qualified to refinance under HAFA program for an even lower rate. When they refinance the home, you just got your note paid off at $100,000, which was bought for $50,000 and you helped a family stay in their home.
Deed in Lieu
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 and it is best to let the servicer work out all the details and make sure you get a clear title to the home. Many banks try to get a Deed in Lieu because it is much cheaper and less involved than a foreclosure.
Long-term hold on NPLs
One strategy regarding non performing loans is to make them a performing note with a loan modification as described above and then keep the note. The investor who purchased the NPL now has a performing note and the borrowers will be making their payments to the investor as long as they own the home. Once the note becomes performing it also becomes much more valuable and could be sold on the market to another investor who is looking for a performing note.
If you are able to get a big enough discount on the note and renegotiate a payment amount with the borrower you may be able to make returns higher than 20 percent on your investment.
Short sale on a non performing note
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. The investor should be able to make a nice profit even after paying real estate agents and closing costs due to the low cost of the note. If there are other loans on the property then you would have to negotiate with those lien holders and it gets much more complicated, but is possible. Here is an article that explains the short sale process.
Foreclosure on a non performing loan
If an investor has tried a loan mod, tried a short sale and nothing is working than foreclosure might be the only option. If anyone is thinking about buying non performing loans I would always calculate profits based off the worst case scenario and that may be foreclosure. Costs of a foreclosure can be $5,000 to $7,500 on a low value property in a state with an easy to complete foreclosure process. 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 could rent the home, sell it as is, fix it up or even price it so low at the foreclosure auction that another investor buys it at the auction. One very important thing to remember with a foreclosure is how 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.
What companies sell non performing loans?
I have no experience with any of these companies.
I am very intrigued by the possibilities of buying non performing loans for flips and long-term rentals. I have attempted to find some NPLs in my market; Colorado, but there are very few right now. I plan on doing more research and maybe I will venture into this field some day.