Over the last couple of years, the inventory of non-performing second mortgages has shrunk considerably. What was once an ongoing, steady flow of loans from banks, hedge funds, and other investors has now become somewhat of a treasure hunt.
Some say the second mortgage market has been sizzling out because of a lack of inventory. Others claim the banks are holding off from releasing these loans because they’re waiting to see what regulations and/or restrictions the government and/or banking industry will impose upon them. Optimists even believe the banks are waiting to release trillions (yes trillions!) of dollars’ worth of debt.
Rumors have spread that, within the next year or two, a lot of HELOCs will reach maturity and their balloon payments will become due. The belief is a certain percentage of these borrowers will not be able to pay their balloon payments and thus become non-performing. This should give investors a new supply of distressed notes.
Who knows where all this speculation will take us? What’s important is what’s happening now. Where are all the good loans? Are there any good loans left? Can we still make money? We’ll get to that in a moment…
Over the last several years, I can’t tell you how many phone calls, emails, and texts I have received from clients and other investors asking, actually, begging me to find them loans. The problem has been twofold…
On one hand, because of the lack of inventory, most buyers have had to buy loans from companies who have supply, but ones they’d prefer not to do business with. Whether they’ve had previous issues with these companies with regards to getting collateral materials or with resolving problems, the general consensus has been that most buyers feel they’re caught between a rock and a hard place.
On the other hand, the loans that are available for bidding have been sold at astronomical numbers. These so-called “preferred” loans–you know, the ones where the borrower is current with their first mortgage and has some equity in their house (and they live on the west coast) are so over-bid it’s next to impossible to get a decent loan for a decent price.
Because investing in distressed notes is no longer a well-kept secret, a lot of folks have ventured into this gold rush. With this influx of investors, the realistic price of a “preferred” loan has been extremely over-inflated.
The problem with over-buying these types of notes is based on what I always preach, which is the success or failure of any loan begins and ends with what you pay for the loan. How does an investor, who has overpaid for the loan, expect to make a profit when it can sometimes take four plus years to break even? In addition, there’s no guarantee the borrower will even continue to pay.
Here’s the good news: I know where the good loans are! They’re still out there and waiting to be bought at pretty reasonable prices in order to make you reasonable profits. However, if you’re expecting to buy the cream of the crop on every purchase, you’re going to be pretty disappointed.
At the last seminar I spoke at, I was bombarded with investors asking me to send them loans to look at. I had people make me “pinky-swear” that, as soon as I got back home, I would do just this. Well I lived up to my promise, but you know what? I heard crickets. I sent a pool of 20 loans out to 100 of my clients and only got 12 bids back. Where were all those desperate people I left just days ago with their bids? When I called some of them, their response was, “oh, I was kinda hoping that you’d send me some good loans, where the borrowers are current and there’s some equity.”
I explained to several of these buyers that you shouldn’t just focus on the low-hanging fruit. You need to look beyond that layer and start focusing on the next layer of branches. In this new sweet spot, you’re going to pay less for these loans and have a potentially larger profit margin. Sure, there’s more risk, but for every one “preferred” loan you’re over-paying for, I can buy two of my kind of loans.
Let me give you an example. I recently purchased a non-performing second mortgage on a home in upstate New York. The borrower took out a loan four years ago for $40,000 and never made any payments. The past due interest and late fees totaled another $25,000.
During my skip tracing, I found my borrower, but at a different address. When I called the telephone number I had, the woman informed me she was, in fact, the borrower and she took out the loan for her daughter, thinking she had been the one paying off this loan. I ended up speaking with the mom and daughter and, after trying to work out some type of settlement with the daughter paying me $400 a month, the daughter decided it was best if they just sell the house. The house is now up for sale and will probably sell for $160,000. I’ll get my $40,000 and probably $10,000 of the past due balance.
I paid $2,500 for this loan.
In another example, I purchased a second mortgage on a home in the Bronx. They owed $500,000 on the first mortgage and $150,000 on the second. The house was worth about $475,000. Again, this borrower hadn’t made any payments for over five years. When I finally tracked her down, she informed me she thought when she refinanced her first mortgage five years ago, the bank also included her second mortgage. She had no paperwork to confirm this and so, with the help of a Spanish translator, we were able to get a commitment from her to start paying $1,000 a month (instead of $1,700). We set her up on our free ACH/Direct Deposit program and have started receiving her payments.
I paid $5,000 for this loan.
What I don’t understand is, after the origin of these two loans, they were bought and sold four times (including me) and each of these borrowers hadn’t paid since their origin. Believe me, I’m no rocket scientist, but how come I was able to track down these borrowers and get them to start performing when no one else before me was able to?
The point here is that these are just examples of typical non-performing second mortgage notes. I’m not saying all of these types of notes will perform like the examples above. However, what I am saying is there’s a lot more of these types of loans you can buy between $.05 to $.10 on the dollar, and if you know what you’re doing, you can expect to receive some pretty decent returns.
To be fair, let’s look at the flip side of this coin. The types of loans I’m suggesting you look into for investing purposes certainly come with their fair share of danger. It’d be nice if I told you these types of loans never have the potential to undergo foreclosure or bankruptcy, but the reality is with these types of loans, there are a higher percentage of these things happening. It’s a matter of whether or not you want to pay less with more of a risk, but then potentially earning a greater return. It’s also crucial that, with these types of loans, you do a thorough job with your due diligence.
So, you have a choice. Until the banks start releasing their distressed notes, you can either continue to pay through the nose for your “safe” notes, where you’ll basically be managing a cash annuity. Or you can take advantage of what’s already out there and be ready to be plucked. You might have to climb a little higher and you might get scratched up a bit along the way, but in the end, you’ll find it’s well worth it.