What is a Distressed Mortgage or Non-Performing Note (NPN)?

In simplest terms, a loan for the purchase of real estate, is secured by a mortgage (or deed of trust) and a promissory note.  When a borrower fails to repay for 90 days or more, the note is considered non-performing.    If the borrower fails to repay the debt as agreed, the lender has a lien against the property through the mortgage and can foreclose on the property to redeem their capital. 
 
Oftentimes banks and lending institutions don’t want the hassle of working with delinquent borrowers, so instead they sell the notes at a discount rather than go through the process of foreclosure. This can save the bank a lot of time and expense, and allow them to quickly recoup an acceptable amount of their original investment.

​The Opportunity

In the years since the financial crisis of 2008, US banks and lending institutions are still saddled with hundreds of thousands of defaulting mortgages, and have been selling off millions of dollars of non-performing notes to smaller investment firms.   As of Q2 2021, approximately 4.1% of mortgages or 2.35 million homes were behind on their payments or in foreclosure status.  There was about $420 billion of debt that was delinquent  (loans 30 or more days past due), with approximately $300 billion in debt seriously delinquent (loans 90 or more days) or in the foreclosure process.  Prior to the COVID pandemic, there was still a hangover of defaulted mortgages leftover from the financial crisis, however there are now 1.5 million more such serious delinquencies than at the onset of the pandemic, nearly five times pre-pandemic levels.  This is expected to increase once forbearance plans end through the last quarter of 2021.
(Source: Black Knight Financial, Experian)

We have developed a niche in purchasing distressed mortgages or non-performing notes, then strive to keep borrowers in their homes either by allowing them to catch up via repayment plans, or by modifying the payments, reducing their interest rates or principal. If we cannot resolve this with the borrower, we acquire the property in exchange, only if it makes economic sense to do so. ​ The recapture of capital for these loans can then be effectuated through 4 main exit strategies, namely: Loan Modifications, Short Sales, Deeds-In-Lieu (DIL), Foreclosures. ​​

Loan Modification

Generally the most desirable exit, and it's a win-win for both the investor and the borrower, particularly if the loan in underwater.  Since these underwater notes are generally sold as a percentage of as-is property value, it allows us a great deal of latitude in modifying the principal balance and/or interest rate lower, forgiving arrears, and therefore the borrower a lower payment.  This strategy also occurs most often on properties that are still owner-occupied or if there is considerable value in the property which the borrower has kept up.  Once the loan is modified and the borrower begins to make payments again, the note is now “re-performing” and can be resold on the secondary market for a higher value due to the steady stream of cashflow. ​

Deed-In-Lieu (DIL)

​If the borrower is no longer able to afford the current contractual payment and there are no alternatives to get them back on track, we will encourage them to deed the property back to us to avoid the time and expense of a foreclosure action.  Many of the options above could also include a cash incentive (aka Cash-for-keys). The amount differs with each case and could be anything from a few hundred dollars to several thousand. It’s a win-win whereby we help the borrower with the expense of moving and finding a new place to live.  This can also help the borrower work through their current financial difficulties and preempt a foreclosure on their credit record, but cooperation of the borrower is required to do so. 

Short Sale

Sometimes the best tactic for the borrower is to avoid foreclosure and sell the property.  If the potential buyer’s offer is not sufficient to pay off the loan, we may agree to accept less than the total amount due under certain conditions. This situation is commonly called a “short sale.” The main benefit of this exit is that it avoids taking ownership of the property, with the expenses, liabilities, and unknowns which accompany it, but it requires the cooperation of the owner.  If cooperation of the borrower is achieved at the onset of the note purchase, then the property sale can occur in as little as 2-4 months. ​  

Foreclosure

Foreclosure is the worst case scenario exit because it incurs the greatest expense.  However, the benefit of foreclosure is that it is always an option if we have purchased the note properly, as it wipes out all junior liens.  Foreclosure timelines can vary greatly from state to state, and depends primarily on whether the state uses mortgages or deeds of trust for the purchase of real property. Generally, states that use mortgages conduct judicial foreclosures and take much longer while states that use deeds of trust conduct non-judicial foreclosures.  Because it is the most costly of the exit strategies, it is used as the primary yard stick to measure the feasibility and minimum projected return of any potential non-performing note investment.