Buying non-performing loans or notes is a great way to invest in real estate. Non-performing loans are loans that the borrower is behind on or has stopped making 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, you can usually purchase them at a large discount. After an investor purchases a non-performing loan (NPL), the investor can take many different avenues to profit on the loan, from loan modification to foreclosure. I have never purchased an NPL myself, but I am considering it as a way to buy more homes that I can either fix and flip or hold long-term.
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History of non-performing loans or notes
In the past, the bank that owned the loan serviced most non-performing loans. The bank would do their best to get the borrower to pay the loan by offering loan modifications, allowing a short sale, or in the worst-case scenario foreclosing and taking over the property. In today’s market, many banks are no longer servicing their NPLs, they are selling them to investors.
When banks want to get rid of their NPLs they package up a large pool of them and sell them off to the highest bidder. Usually banks, servicers, or hedge funds buy these pools. 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 a bank because the banks sell them as large pools of loans spread out across the country and cost hundreds of millions of dollars. However, more companies are breaking apart the pools of NPLs and selling them to individual investors.
How can an individual investor purchase non-performing notes?
A few hedge funds are purchasing large pools of notes and then selling them individually to investors. Many companies purchase large pools and either auction the notes to the highest bidder or list them for sale as they would a home. You can find many note companies that sell individual loans or small packages online.
What are you buying with non-performing loans?
What you get with a note depends on what type of loan you are buying and on 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 that the loan is against. In some cases, you may be buying second position notes, which are much less valuable. A second position note must pay off the first note in order to gain possession of a property and it could be wiped out in a foreclosure.
When you buy notes, the house that the note is against may have unpaid liens. The house may have unpaid taxes, city liens, or judgments against the home. It is very important to do a lot of research on any note you want to buy in order to make sure you are actually 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 in which to invest. NPLs offer an alternative to what is available on MLS. You can purchase some notes for 50 cents on the dollar or less. Buying notes at 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. 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. Fortunately, many servicing companies can help with short sales, foreclosures, and loan mods. They also make sure that 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 work diligently to keep a homeowner in the house while other investors foreclose and take possession of the property.
How to make money on 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. Let us 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 cannot 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 the Home Affordable Foreclosure Alternatives (HAFA) program for an even lower rate. When they refinance the home, you just got your note paid off at $100,000, which you purchased 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. 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.
Long term hold on a non-performing loan
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 you could sell it 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 then re-negotiate a payment amount with the borrower, you may be able to make higher than 20 percent returns 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. 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.
Foreclosure on a non-performing loan
If an investor has tried a loan mod and a short sale but nothing is working, 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.
Which 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 for long-term rentals. I have attempted to find some NPLs in my market, Colorado, but there are very few right now. I plan to do more research and perhaps venture into this field one day.