Volunteering to be the Bad Guy? - A Moral Inquiry on Note Buying

[Troy Zsofka]

I must say that I find the idea of purchasing Non-Performing Notes to be somewhat fascinating. With a degree in economics and a stint in commercial finance, the complexities of the moving parts attract my mind's interest. However, I have one main hesitation, and it's not based on any sort of financial risk analysis. Rather, it's 100% rooted in the one thing that should never be a part of any responsible business decision - emotion.

I've been buying post-foreclosure properties for several years, and my father before me for many years prior. Never felt guilty profiting off of the fact that someone didn't pay their mortgage. The main reason I haven't felt a single ounce of guilt, regret, or hesitation, is not that the people got what was coming to them for not paying, but because of the 1 degree of separation. They were kicked to the street by the bank, before we ever entered the picture, and we had nothing to do with it.

Now, I'm a firm believer that if you sign the dotted line and cash the check, you are responsible to make your debt service payments. We're all adults, and the idea that people need to be protected from their own irresponsible financial decisions is ludicrous. You're a big boy now, so pay your bills or suffer the consequences. However, things are not always so simple. Sometimes, people default on their obligations, not because they bit off more than they could chew, or because they didn't prioritize responsibly (and bought a shiny object with their tax refund rather than putting it in the bank), but because of something out of their control, like an accident, or an illness. Now, call me weak, but I don't want to be the person who makes the decision to kick a family out of their house when default was for a reason beyond their control (like death or illness of the bread-winner). Maybe buying the house after the bank has done the dirty work amounts to the same, and I'm just hiding behind that one degree of separation, but I don't think so. 

You see, similar situations can happen with tenants. The difference being that I didn't personally put myself in that morally difficult situation. They qualified at less than 28% DTI (meaning that they earned over 3.5 times the monthly rent in gross income) when I signed the lease. With NPN's, on the other hand, I would be intentionally investing into the situation already knowing that my exit strategy may be to force a family out of their home.

That still leaves the door open to the idea of purchasing a NPN at enough of a discount that you can take a haircut on the balance, thereby reducing the mortgage payment to something they can afford, and still make a nice profit. In fact, I think that is likely one of the main strategies of note investors. Problem is, I'd need more exit strategies than just restructuring, and if I'm not committed to kicking them out without hesitation, it's probably not the business for me.

Perhaps if I researched it a little more and found that the vast majority of NPN purchases ended in either a loan mod resulting in a performing note, or in a mutually agreed upon deed-in-lieu arrangement, I wouldn't have these hesitations. I guess I just don't want to go into a situation where I already know I'm likely to have to be the bad guy, regardless of how profitable it may be.

[Troy Zsofka]

@JD Martin, I agree 100%; which is why I have never felt bad about buying REO's.

I think the main difference is that, even with a bank who has to be the bad guy and foreclose on someone, they didn't go into it with that in mind. They did their due diligence through underwriting and felt that they had a solidly qualified borrower who would perform on the mortgage obligation. With NPN investing, the investor is voluntarily entering a difficult situation.

However, as explained by @Mike Hartzog and reiterated by @Wayne Snell, if the initial intention is to come to a conclusion that is mutually beneficial to both the investor AND the mortgagor, I think that the moral issue does not apply, and a the mortgagor who is unwilling to compromise is probably the kind of person who doesn't feel bad about failing to meet their obligations anyway (and therefore deserves no consideration in return). On the other hand, if an investor is just looking to foreclose on the note and then flip the property (either for resale or for stabilization and hold), then that investor is sacrificing moral fiber for profits. 

The world is full of both, but I do believe that NPN investing can be done in a way that looks to benefit both the investor AND the mortgagor.