Non-Performing Notes, What the heck are they, and why should I care?.
We all know someone who has a mortgage problem. Think back ten years ago when they bought their house. They bought a two-hundred-thousand-dollar house. They had about twenty thousand to put down, so they took out a hundred and eighty thousand mortgage. They figured, “The market’s on fire. In a year, it’s going to be worth two-fifty, two-sixty. In a couple of years, it’s probably going to be worth three hundred. If we want, we can sell it. We can pull out eighty thousand dollars and make a nice piece of cash.”
Of course, things didn’t turn out that way. The market crashed and burned. Now, that two-hundred-thousand-dollar house is worth a hundred and seventy. They go to the bank. The bank says, “I don’t want to refinance you.” They’re stuck with it. Time moves on. Now the house is worth a hundred and forty thousand. They’ve got a hundred-and-eighty-thousand-dollar mortgage for a hundred-and-forty-thousand-dollar house. What do they do? They stop paying. The bank doesn’t have a mechanism to work with that, so they just sit there and they wait, hoping that they’re going to start paying again.
This goes on for years…along comes a hedge fund. Who has a pile of money to buy these mortgages. They go to the bank and say, “that mortgage hasn’t paid in years. Every year you write some of it off on taxes to offset your profit. You know you’re not going to get a dime of it. You’ve written off so much of that loss, that its worth zero on your books. Why don’t we just take it from you? We’ll pay fifteen cents on the dollar Okay? Ok, ok. Fine. We’ll pay twenty two thousand.” They think about it and they say, “Twenty thousand versus nothing,” and so they sell us the note for twenty thousand.
Now we’re the bank. We now have the IOU and the ability to foreclose if we can’t get the homeowner to pay something. We go to the homeowner. He’s upside-down & he has no idea who we are, or how we have his IOU, so we introduce ourselves. We’re your new bank, and since we’re not a traditional “bank” with all the federal regulation, we can be flexible. We get that you don’t want to spend the rest of your life paying on a mortgage that is worth far less than it used to. The house is worth a hundred twenty five thousand now, What if we rewrite your mortgage to a Hundred-thousand dollars & we’ll do it at eight percent interest. Of course, after thinking over the numbers for ten seconds, he says, “Great. Now I only owe a hundred thousand. My mortgage has basically been cut in half.” He gets to stay in the house. He doesn’t have to worry about the big credit ding, if it hasn’t already happened, so everybody’s happy.
We repair the note, which means we take payments from him for three, four, five, six months, consistently. Then we wave our note around. We say, “Look. We’ve got a hundred-thousand-dollar note that’s making eight percent.” We’ve got all kinds of people wanting to buy those notes. Now we could sit there and take your payments. We’re in at eighteen or twenty-thousand dollars. We’re taking payments on a hundred-thousand-dollar loan. We’re making money, but if you want to keep the cash flow moving, then you’re going to sell that note off. You might take a couple points off. Maybe it will be at ninety cents on the dollar. Then you go in and use that money to buy another note. You kind of see the way the process works.
The core of this business model is that we are able to buy these “toxic” assets from the bank. They clean up their balance sheet and decrease their taxes, then sell to us for pure profit. We get a very valuable asset for cheap and it is secured by a house worth many times more than what we paid
Why the heck are banks selling something worth $180,000 for $20K, $30K, or even $40K dollars? Remember this: We are going back three to six years ago. You can’t get those kinds of prices now, but six plus years ago, what the bank’s thinking was this: the people that buy bank stocks are institutional buyers, they’re mutual funds, big buyers. They buy stocks based on ratings. The ratings are based on how much good debt they have, and they get penalized by how much bad debt that they’re holding. The worse their rating is, the less institutional buyers they get, the lower the stock price is worth. They’re very incentivized to get rid of these notes, these toxic assets, this bad debt. These hedge funds buy thousands of these at a time, so the bank has good reason to clear the junk and get cash instead.
So that’s what’s been going on for almost six years. Buying these notes at a thousand at a pool and then working these notes out with the homeowners. Of course, the workout is easy when you approach somebody that owes a hundred and eighty thousand and you offer them a loan of a hundred thousand, they’re going to take you up on it. They don’t even care about the interest rate. You just cleared up two major problems: 1) am I going to be foreclosed on, and 2) how the heck can I get out of my mortgage debt that I don’t have $80K to clean up?
You are going to get the guy who says, “Screw you, I haven’t paid the bank in years, and I don’t plan on it now”. Fine. You call a local foreclosure attorney and he will do the work. You foreclose on them. Now you have a house for a low amount (eighteen or twenty thousand). Sure there will be other costs like taxes that might have not been paid, or part of the HOA, or condo associations. You are going to have other costs, but look at it this way, you’re getting a hundred-and-forty-thousand-dollar house for twenty thousand for your note, plus all your other costs. Maybe you’re in $40,000 with all your attorney costs, fees, taxes, liens etc, but you’re still making great money. That’s kind of in a nutshell how the note business works.
But I don’t have a 50-million dollar hedge fund. How can I get started? That is exactly the right question. Isnt it time you called so we can find out if there is a way to work together?