How would you make money in this scenario for a non-performing 2nd

Question

So here is the scenario:

First Lien is $150,000

2nd Lien is $40,000

FMV: $80,000

Borrower is 120+ days late on both mortgages and is in Chapter 7 Bankruptcy.

Assuming the Property Taxes + Late mortgages there is about $20,000 in Arrears

Borrower lives in New York

Seller will sell you the 2nd at $3,000.

What could you do or what would be possible and what steps could you take to make this deal work?

Gilbert Ross Jr · Answer

This is not a good deal. Ideally you want to buy 2nd liens with a preforming first lien. This person is getting rid of all there debt and that will leave you in a bad position. This type of lien should be purchased as a part of a pool of 2nd lien notes. This way if this one didn't work out you could have other liens that might be profitable.

Dion DePaoli · Answer

If the borrower is in BK, you have a stay from collection activity, which includes foreclosure.  Bob is right, you will need relief from that stay in order to do anything...which includes talking to the borrower.  If the debt for the second lien is indeed discharged in the BK, there is no chance for a deficiency as stated.In regards to the possible resolutions.  Taking possession of the property through DIL, not short sale, since you would be a Mortgagee you already have an interest, you would simply operate the property looking to the rents received to recover your investment.  Nothing wrong with that if you take possession properly.  All that said, I am not sure I would reinstate the first position, that just means you are increasing the amount of money you need to recover.  That includes any additional capital injection into the asset including but not limited to taxes and debt service on the first.  The DIL you as a second line holder executes can only release the borrower from the liability of the lien you own, not that of the first.  If you did a DIL you would not obligate yourself to service the first lien nor would you have the ability to absolve the borrower of any liability from the first lien.  I can appreciate @Bob Estler dirtbag comment, but in this case, it would not be a dirt-bag move to simply try and recover your invested capital while not paying the first or even the taxes under the presumption the first will maintain the taxes as needed.  As a lien holder there is no mandate to advance funds for such things, only a resolution if funds are advanced.  The lender does not have to protect it's interests nor does the title owner, it just has to face the consequences of such.You could look to purchase the defaulted first and in NY if no foreclosure is started, you might just get a decent price (low in compared to FMV).  That would likely be the most idea strategy.  NY assets seem to be asking for some decent execution lately though.I would not expect the first position to forgive principal so much as to bring the first UPB in line with property value.  While anything is possible, it just is not likely.

Bob E. · Answer

A few things you might want to consider.  If my notes serve me correctly, in New York a chapter 7 BK wipes out the liability to repay any deficiency so Outcome 1, #1 may not work so well if the borrower in in BK.

As for Outcome 1 #2 i was looking at the rent payment as a kind of last ditch effort to get something out of the loan.  While this may work and the lender for the first may write down the balance or work with you in some way it would be interesting to see how much help they are going to really give you.  Say they were having a great day and wrote the balance down to the current value (80k).   Now you have an 80k loan on an 80k house.  Sure you might cash flow a little on it over time but, as a note investor this is not usually the business you want to be in, if it was you would have just bought an REO for 80k and tried to clear $100 per door per month.

Outcome B:  Borrower wants to stay:

You do have a lot of flexibility to lower the payment for the borrower but you also very likely dependent on the holder of the first also doing a workout, if the 1st lien holder decided to FC then you are sunk due to the lack of equity.  Outcome B works better if you are buying a first lien and there is not second.  If that is the case then you have all kinds of flexibility.

Not trying to a be a jerk or rain on anyones parade those are just the shorcommings I see with the proposed solutions.

Bob E. · Answer

Leo, good point on the opening bid, it is always possible that someone might make an offer that would net you a profit.  Only downside is you would be profiting from someones ignorance.

I would look for situations where the borrower is current on the first.

Taking possession only makes sense if you can sell for enough to pay the first or rent for enough to cover the mortgage and recover your investment + profit from the Cash Flow.

Chapter 7 would slow things down but is not the end of the world.  The biggest things in this  scenario is that the borrow is not current on the first so they very likely have little or no intention of staying in the property AND they are massively upside down so there is no reason to expect anything to come your way in a FC.

This is one reason I like first position notes, figure the value of the collateral vs. the costs of the Note + FC + holding cost and you know your worst case scenario.  If you get the buyer to re-perform then great.  I know lot of people like seconds and are good at them, I just haven't reached that  point yet.

Arthur Mayer · Answer

Hey @Tasha McKoy

No this is purely Hypothetical. However it is a type of note I would like to add to my inventory because I know it's a type of not that most people would touch due to it's high risk.

Tasha Mckoy · Answer

Arthur,

May I ask how you acquired this Note?  Did you know all the initial information when you purchased it?  Did someone sell you this with misleading information?  Just curious?

Leo Koo · Answer

@Ian Barnes Thank you. That helps put things into perspective.

I guess the play would be to include this in a pool and blend with some equity notes. This would be a tough play either way.

Ian Barnes · Answer

Hi Leo, we've spoken once or twice on the phone, so hi, hope all is well. I'll let others tell you how to play out this note, but I could buy this note for between 1%-2% of UPB in a smaller pool, so 3K is very expensive for the 2nd.

Pete Nater · Answer

It seems to me that there is a chance, if the owner would share the 1st lien holder info and provide you with authorization for you to contact the lender, that you can ask the lender if they might sell you that NPN at a discount, like 20% of UPB ($30K) or 40% of FMV ($32K). You never know, they might not want to get stuck the property and accept your offer. Especially if the owner is BK. Then you'd own both notes for $33-$35K.

Lots of ways to monetize a deal like that at that price. I could think of 7 ways

Arthur Mayer · Answer

Let me attempt to answer my own question based on the knowledge I know, and if a more experienced note investor feels my information is incorrect please chime in.

I'll break this down into Two Scenarios:

A) The borrower's motivation is to sell the property/let it go and

B) Outcomes based on the borrowers wanting to keep the property.   Again this the outcomes I am perceiving based on my limit knowledge and expertise.

I am also going to assume you can contact the BK Attorney and he is somewhat flexible or willing to work with you.

A) Borrower is not going to pay and is planning to sell/let the property go

Outcome 1 :Since the borrower is no longer liable for the debt on the property a work out package with the borrower is not going to happen, and it looks pretty gloom.

Actions to take/Exit Strategies #1:  It does not remove the debt from the property; only the borrowers liability for the debt and the only action you can take is proceed with foreclosure process after the BK is discharged. Let's assume the property sold at about $80k on the foreclosure auction.  Obviously at this point since the property's value did not compensate paying off the first, any taxes and your 2nd.  Now as mention above, the State this foreclosed in is NY, so as a secured lien holder this state DOES allow you to do a deficiency judgement against the borrower for the amount owed on the property. In essence, you are suing the homeowner.  (http://www.alllaw.com/articles/nolo/foreclosure/an...)  Probably the worst case scenario due to the cost of doing a deficiency judgement plus, the borrower probably doesn't have many assets. Can't squeeze blood from a stone as they always say. So you may not only lose your capital, but the additional attorney costs of going this route.

Actions to take/Exit Strategies #2: Proceed with the same procedure as above. I am assuming a Deed in Lieu or a Short Sale will not allow you to profit due to the lack of equity (Correct me if I'm wrong). The second exit strategy you can do is reinstate the first in foreclosure as @Bob Estler mentions above (which goes to show how important due diligence is with rent rates on dangerous loans) since your 2nd is "Paid off" you can see if you have the rent rates cover the cost of the mortgage and maybe hope that the 1st lien holder will be able to do a modification to reduce the monthly liability since the property is upside down.

B) Borrowers motivation is to keep the home

Actions to take/Exit Strategies: So again, I'm assuming the attorney is willing to work with you, since you aren't allowed to talk to the homeowners, although I've listen to a program where the investor had "accidentally" contacted the borrower and did a workout package directly with the borrower.  Obviously in this example, the attorney probably didn't have the homeowners best interest doing a Chapter 7 vs. a Chapter 13 according to my research. (Again, I could be wrong with this). However, if you have the cooperation of the attorney, you can do a pretty nice workout package with the borrower through the attorney and have  flexibility due to the cheap price you paid for the note.  Since the borrower has probably removed any unsecured debt in the BK, the DTI ratios are probably a lot more favorable for the borrower to afford the home they plan on keeping. Without going into extensive details, you than hopefully see how much of the arrears you can get from the borrower and what payments they can afford on the 2nd. (Hopefully a workout package is being done or was done on the first via Loan Modification and possibly a balance reduction due to lack of equity). This will allow you to cashflow very nicely while giving the borrower a much better payment on their 2nd!

Hope this helps! If any of this information is incorrect let me know!

How would you make money in this scenario for a non-performing 2nd

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