Buying my first note

[Stewart Thompson]

Good morning BP!

So I want to try and buy my first note. I don't really have that much capital, but I want to start out somewhere and learn what is all involved.

I am already registered on fciexchange.com, but really have no idea what I am looking at really. It seems I have too many questions and not enough resources to find those answers. Maybe you can assist me with some of these answers.

Notes 101 (Example: http://www.fciexchange.com/GEORGIA/Conventional/No...)

• When looking at a note, the purchase price is $2,000, which is 19% of the Unpaid Balance ($11,204.95). The note rate is the amount of interest I would expect to receive having invested in this note?
• How does the note rate work? (If it were 12%, would it be just 12% on the $2,000 purchase price making it $2,240, or is it 12% APR which would make $3,852.80 at maturity in 6 years?)
• What does the "Payment Amount" refer to exactly?
• I am not too afraid of the risk, but how to evaluate the risk?
• Is it a good idea to buy notes out of the state in which I reside?
• The investment strategy model doesn't make any sense to me at all, could someone possibly help with this too?

Really, this all that I have understood about notes, what I have been able to find. Basically a person has a 1st or 2nd that they need help with, whether it be performing or non-performing, and instead of foreclosing on the loan the original lender is willing to take a cash payment at a fraction of the original loan. This is what a note is, and so when an investor comes in and says, "Sally, I will buy your loan from your original lender for x amount, which that lender has agreed that they will accept, now you will pay me x amount a month until the maturity date." If they end up not paying, you are able to foreclose, and get money back. One can do all of this without being a real estate agent, which I am really interested in myself. Please feel free to correct any of this that is wrong, again it is what I have come to understand in my limited knowledge.

Sorry this is so long, its just not something that is very well explained, no one I know even knows this exist, so I feel like I am a little fish in a big sea, but have no idea where to start.

Thank you again ahead of time for assistance and guidance.

[Dion DePaoli]

The note rate is the amount of interest charged on the note. The rate of interest is what the Borrower pays not necessarily what the investor/mortgagee makes. If an investor pays par for the note, which means paying the same as the total amount still due (called UPB = Unpaid Principal Balance) the rate of return would be around the interest rate. An investor can pay par, premium (above the UPB) or discount (below UPB). Discounted loans create a higher potential rate of return than the interest rate because you are paying less than what is due in principal but the borrower still owes the UPB and interest. The opposite is true for premiums, the investor would receive less than the rate of interest. Some variations exit in those ideas in regards to remaining term but we will leave that aside for now.

The payment amount is the what the borrower is obligated to pay currently.  It is worded as it is because a borrower can create an agreement to pay something other than the payment due on the note.  A forbearance is an example.  The Mortgagee may forbear the payment and allow the borrower to pay less than the full payment for a period of time, perhaps during a time of hardship.  A forbearance is not a permanent change in the payment amount (or any note term) it is temporary and at the end of the term obligations go back to what the note stipulates.  A note can be permanently changed by a modification.  Often times those require a trial period before permanently making the change which is actually a forbearance.  

A borrower does not seek out an investor to purchase the note.  The current note holder does that.  A borrower can not create a sale nor does the borrower have any influence on the sale as they do not own the note to sell.  A new note investor is under no obligation to treat the loan in any other manner than how it is written.  Once the borrower signed at origination, that created the obligation in full.

In this particular note you would they want to sell for $2,000 and the borrower, if they make all 12 payments would pay out $1,1368 which is around 68%.  A great potential return but the next question would be how realistic is it to get the borrower to pay?  More on that in a moment.

The remain term is 62 periods.  (Jan 2016 to Mar 2021)  The borrower over the course of that time would pay $7,180.  Not enough to cover the UPB.  So this loan would have a balloon.  That means the amount of principal on the 62 payment will be larger than the payment due of $113.98.  We know from reading the Seller's comments the loan is modified and because we don't know exactly what was modified speculation into the terms not provided can be misleading.  If we assume the term was not modified and this was indeed a 15 year mortgage the rate of interest of the current payment is 8.76%.  As I stated above though, $113.98 per month will not pay this loan to zero in the remaining 5 years so I am guessing the Mortgagee lowered the payment by lowering the rate.  

As to that modification, this was probably a loan that should have never been modified.  The original balance was $11,400 and it is now $11,205.  So the borrower only paid $205 in principal in 10 years.   It may have had an interest only feature to it and when the payment reset the borrower couldn't afford it.  It's hard to say without more information.  However, entering a mod to then file BK shortly after is not a good sign of a well placed modification.  The borrower still owes over $6k in interest arrears and with such a small loan amount that past due has been accumulating for a while.  Also a sign of a sloppy modification.

The borrower's BK filing creates a stay from the any creditor trying to collect a debt. The BK plan will usually take the past due amounts on the loan including fees and create a payment plan from the BK plan to pay the debt or a portion of the debt. The borrower would then be responsible to service the debt moving forward, sort of like starting fresh. Usually that is not a bad deal for a Mortgagee as they would get the payment due under the note and the payment due from the BK plan. However in this loan's case the "MFR" reference would be relating to a Motion for Relief of Stay. That is BK talk for the creditor asking to be relived of the bankruptcy order to refrain from collections. That is a indication that the borrower is not making good on the loan obligation outside of the BK. In other words, the borrower is on the verge of defaulting again.

The conclusion or writing on the wall seems to indicate foreclosure on this lien is eminent.  So we would look to the amount of equity above the first lien of $45k to see if there is any chance of recovering on this lien.  We know generically the second lien's total payoff is actually north of $17k (UPB plus interest arrears).  There is a decent chance the senior lien has charges due above their $45k balance as well.  So the amount of equity for you to recover from is fleeting.  Further, we don't know if the value of the property listed is accurate.

If you bought this for $2k you would have to dump additional money into it.  There is a cost to servicing the loan and legal costs at the very least a couple thousand on top.  If we say generically you would shoot to recover $5k to make it all worth while with a small profit, that seems like it may have its issues.  A property won't sell at full value at foreclosure sale. It is not all that wacky to assume the first liens payoff is closer to $55k to $60k or about $10k  to $15k above their balance.   So the property would need to sell at auction for $60k or better to ensure you get some dollars back.  If the property doesn't sell at auction at all and it reverts to the foreclosing first lien you would get nothing unless you sue the borrower on the note.  

You could buy the note and run foreclosure yourself from second lien but that may not be afford you any recovery either and you would increase your costs to foreclose.  Probably not the best idea.  

The overall conclusion is this lien is a lemon.  The current Seller is trying to dump it on someone else and make some money back.  That seems to be writing on the wall.  I rand through all of that detail to help you see and hopefully start to understand in the world of notes a cheap price doesn't mean a good asset.  Note investing is not an inexpensive endeavor and there are risks that can result in zero money back.  

There is a forum here on BP "Tax Liens, Notes, Paper & Cash flow" which has many threads on matters surrounding note investing.  You will find a bunch there to help you on your education in the asset class.