Five False Facts About Investing in Distressed Second Mortgages

I’ve been investing in distressed second mortgages for over 17 years. I’ve seen a lot of changes: some based on the economy, some based on supply and demand, and some based on falsehoods new investors have held onto while entering this industry.

While you can’t control changes within the economy or supply and demand, I believe you can do something about falsehoods and misrepresentations.

About two years ago, I started Keyhole Academy, an online education program teaching students how to invest in first and/or second distressed mortgages. I wanted to apply my years of experience and put it in a format I felt people would most benefit from.

While trying to solicit potential students who either weren’t investing at all or just investing in first mortgages, here are the top objections I received:

1.  I Don’t Feel I Have the Time to Learn and Invest

This was by far the biggest concern I heard. Many potential students had full-time jobs and thought both learning and managing their investments would take up too much of their valuable time. This couldn’t be further from the truth! On average, my students finished studying my 26 chapter online course, “The Business of Investing in Distressed Second Mortgages,” within three weeks.  This only entailed reading about one hour per day!

As far as “running” the business, this is up to each individual and how much time they want to put into it. Perhaps one of the most time-consuming chores is finding loans to purchase. Yes, there are other investors and small hedge funds to buy loans from, but the real reward is if through your own research and networking you’re able to find a new source with new loans. Now you’ve struck oil!

Once you’ve done the proper due diligence and purchased your loans, the rest is easy. Let’s say you purchased five distressed second mortgages. After you file the Assignment of Mortgage and send out your Welcome Material, it’s now down to contacting your borrowers. The first month you start calling and find one or two borrowers will start paying their monthly mortgages they owe. Maybe another borrower wants to settle with you on a short sale. And the other two borrowers either can’t be found or refuse to pay. At this point, you pretty much know where you stand and what you have to do.  Maybe you spend one to two hours a week managing your portfolio.

If someone asked you in exchange for an extra 6-8 hours of work per month you could have the opportunity to increase your money by potentially 25-30%, what would you say?

2.  I Need a Lot of Money

No matter what you’re going to invest in, you must ask yourself:

a.  How much money do I want to invest?
b.  How much money am I realistically looking to make?
c.  What is my risk tolerance?

When I compare investing in distressed first mortgages versus distressed second mortgages, the differences are quite clear. When investing in distressed first mortgages, you can expect to pay anywhere from $.60-.75 cents on the dollar. This means if you purchase a $100,000-first mortgage, you’ll pay about $70,000 for that note. While there are creative ways to fund your purchase, the bottom line is you’re on the hook for that amount. Additionally, if you were able to buy three distressed first mortgages and one of those mortgages did poorly, 1/3 of your portfolio is affected.

When buying distressed second mortgages, you can buy about five loans for $20,000. Not only are you able to get into the market cheaper, but if one of your loans does poorly, that’s only 20% of your portfolio.

The first question I ask potential investors is: How much money do you have access to and/or are willing to invest?  If the answer is over $100,000, I suggest to invest in both first and/or second mortgages. However, if the amount is below $100,000, they should probably be only investing in second mortgages.

 3.  Investing in Seconds is Too risky

Investing in distressed seconds is risky for the sole reason that it’s in second position behind the first mortgage.  I’ve found that in most cases in today’s economy, if the first mortgage forecloses on the borrower, there won’t be any money left over (surplus) for the second mortgage.

If you want to invest in distressed seconds, this is a fact that you have to accept. A certain percentage of your portfolio will succumb to being foreclosed on and you’ll lose your initial investment for those loans.  Conversely, because you’re buying distressed seconds so inexpensively, on the other loans you’ll see a much bigger return on your investment than you would if investing in distressed firsts (even with the foreclosure losses).

Let’s take a look at five loans I purchased last spring:

  1. Rodriguez      UPB:  $23,485     Paid:  $3,000
    Rodriguez couldn’t afford his $320 monthly mortgage and we agreed on $225 for six months.
  2. Morrison      UPB:  $33,018     Paid:  $4,000
    Morrison began paying his original $477 monthly mortgage.
  3. Witherspoon      UPB:  $17,480    Paid:  $2,250
    Witherspoon refused to pay anything.  I will do nothing as it’s not worth foreclosing on him. We’ll see what happens and I’ll check up on him every 3-4 months.
  4. Luxley      UPB:  $38,185     Paid:  $3,500
    Within the first three months, Luxley was foreclosed on with no surplus. I lost $3,500.
  5. Steinhart      UPB:  $44,700     Paid:  $4,500
    Steinhart and I agreed to a settlement of $20,000.

As you can see by my examples above, even with losing my initial investment on Luxley and not having Witherspoon paying, I’m still on track to be extremely profitable.

What I’ve learned in my 17 years is whether you’re buying five loans or five hundred loans, if you know what you’re doing, statistically, you can expect the same percentages as far as how many borrowers will be paying, how many will be doing short sales or payoffs, how many won’t pay, and how many will be foreclosed on.  That’s the secret to success!

4.  It’s Hard to Find Notes to Buy

Another false fact!  For anyone just starting out and looking to buy notes, the fact is they’re probably only going to buy in small amounts (under ten notes).  With this number, there are plenty of other investors and small hedge funds that are continuously selling these quantities.

The key to conquering this challenge is twofold.  The first is the need to network! In order to find these other investors and small hedge funds, you need to get out there and meet others in your industry.  A great way to do this is through meetup groups, seminars, LinkedIn, Facebook, and other organizations. One of the recommendations I make to all of our students is, upon graduation from Keyhole Academy, they’ll create an email they send to friends, family, and associates announcing the venture they’ve embarked on.  This should include what they’re now doing and what they’re looking for in terms of finding notes.  It works!

The second way to find notes is through good old-fashioned cold calling.  There’s a website called Lane Guide.  Once you join, this website lists every financial institution in the U.S. You can narrow down your search and start calling.  I train my students on how to do this in order to get the most out of their calls.

5.  It’s Too Hard to Learn About Investing

The truth here is, like anything else, if you want to be good at something, you need to work hard. If you want to be really good at something, you need to work hard and smart.

Part of working smart is not reinventing the wheel. That’s why I started Keyhole Academy – so others can learn from my mistakes and profit from my experience.

My online course allows students to go at their own pace and each chapter has quizzes, videos, and audio. A final exam is given at the end. You can repeat the course as many times as you’d like.

Additionally, I offer private mentorships where the student commits to buying either 3 or 5 mortgage notes within a six-month period.  The profits are split 50/50, but we’re holding the student’s hand every step of the way.

It was important for me to address each of the above concerns so potential investors can truly understand the real facts about investing in second mortgages. The truth is I’m continually gaining knowledge by learning from others and sharing that knowledge openly with my peers and students.

Hope to meet you out there.

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