2nd Lien Non Performing Notes and Bankruptcy

[Tehseen Baweja]

As I educate myself on Notes, I would love to know what are some of the strategies and due diligence requirements when looking at 2nd Lien NPN and chapter 7.

Here is an example:

Sale Price: $8k

UPB: $100K

Property Value: $290k

Sr Balance: $400k

Sr Status: Unknown

Chapter 7 Bankruptcy / Discharged

So the property is definitely under-water and there is no information on whether payments are being made to the senior loan. My questions would be:

1. If the Sr is not reporting any payments, is there any other to confirm if payments are being made to Sr or a loan mod is being worked on?

2. Assuming payments are not being made, is it pretty much a worthless deal because most probably Sr will foreclose and wipe out 2nd lien?

3. What are some other strategies and due diligence one should do for a deal like this?

Would welcome any thoughts as I am just starting to learn this area.

[Joshua Andrews]

Hi Tehseen,

I have had several successful workouts with NPN 2nds and love them. I also do NPN 1sts. The due diligence you need regarding this is to confirm the 1st is indeed being paid and is current. This is the biggest deal breaker on the note you described. If you cannot confirm 1st is current, it's typically something to stay away from. That being said, just understand what you are getting into. The home is underwater, and the 1st mortgage cannot be confirmed, which makes for significant risk. I have completed workouts on underwater notes before, and for all my limited experience they are based on emotional equity not on equity in the property. However just understand that if equity is missing it simply removes an avenue of exit from the deal for you, meaning you cannot really "force" the borrower to resume payments, although he likely will if the modification makes financial sense.

Don't let the fact the borrower completed a BK chapter 7 scare you. I like those. It means they have less debt now, and usually more money to pay you. The thing that would kill the deal for me is the fact you have no idea if the 1st is current or not.

The lien is not necessarily stripped in a BK. It simply means the owner is no longer personally liable. You cannot go after him personally for the debt. However the 2nd mortgage still has the right to foreclose and evict the borrower from his home, so that in and of itself is leverage.

With all that being said I would avoid this deal unless you can confirm status of the 1st being paid and current. Lots of other more attractive deals out there. Don't confuse a cheap purchase price with a good deal.

Josh