2nd position exit strategy

Tax Liens & Mortgage Notes
10yFollow

2nd position exit strategy

Tim S.
Investor · California, CA · Member since 2016 · 367 posts · 375 votes

Hi Note People,

I'm trying to learn more about NPN 2nds, and wondering about this scenario: (assume 1st is performing)

If I have a 2nd position Non-performing note, without enough equity to even cover the first, or just barely cover the first, is there any way to make a profit?  Has anyone here made a profit in this situation? 

 I understand that you can still foreclose from 2nd position, but it seems like a bluff at that point. If the borrower calls your bluff and refuses to pay anything, then there is really nowhere to go with it is there? You can still foreclose, but how do you make any money if the sale of the property won't even pay off the 1st?

Are you banking on the fact that the borrower doesn't want to take the chance that you may foreclose on them, and will agree to some payments? I could see this could work sometimes if they are ignorant of how this process works, and they are just scared, and pay up. But if they figure out you really don't have any leverage without equity, why would they pay up?  I expect that most people probably are ignorant of the process, but I wouldn't want to count on that as my only way to profit.

Seems like a longshot to make this work, am I wrong?

0Reply
32 views

Most Popular Reply

Joshua Andrews
Lender · Austin, TX · Member since 2012 · 211 posts · 166 votes
10y

I have had excellent success with underwater assets. There are probably 5-7 or so viable exit strategies even when no equity is present. Despite what it may seem on the surface, a well selected 2nd mortgage with a performing first is a wonderful asset. I buy these almost weekly.

The key is the up-front due diligence. Simply picking notes at random will get you into trouble. The due diligence process is 80% of the game, and also where the heavy lifting is. Also, recognize not all of them work out. This is why you pay a heavy discount both for the risk and the fact they are non-performing. Our company enters into the process with the goal of creating a win/win loan modification for the borrower. However, it is the borrower who ultimately decides what course of action to take. You cannot force someone to do something or take a specific action.

A few ideas on exit strategies.

  • reinstate loan in full and have the borrower make payments according to original promissory note
  • payment plan (forbearance)
  • loan modification (my favorite)
  • discounted payoff
  • sales assistance (sell the home)
  • short sale
  • foreclosure
  • deed in lieu of foreclosure
  • foreclose, then rent the property

There is much, much more to be discussed on this topic, as this only scratches the surface.

Josh

4Reply
See this reply in the discussion

8 Replies

Jump to latestLatest
  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    10y
    Tim Simmons - that is why 2nds that are NPN sell at such a heavy discount. I am not an expert at 2nd's (want to read from Dave Van Horn ) but from what I have learned is if you are looking to invest in NPN 2nd's it is not the wisest to do one-offs but to buy several as not all will become reperforming.
    7e investments53 Reviews
    WebsiteView Page
    0Reply
  • Patrick Desjardins
    Real Estate Investor · Amherst, VA · Member since 2015 · 386 posts · 400 votes
    10y

    You're correct that it has a much higher risk of you losing money, but not automatically. If there's no equity they can file a chapter 13 and try to strip you, but not everyone does it. You can also sit on it until equity comes back (being aware of statute of limitation). They can try a short sale, they can be qualified for HHF, they may have been waiting for someone to call them after loan was sold 12 times.. There are a LOT of different reasons why people stop paying.

    On one of my notes, the couple divorced and the husband was supposed to pay the 2nd while the wife paid the 1st. He stopped paying for XYZ reason and she claims she didn't know about it. She threatened to bring him to court and now they've been paying every month for 2 years like clockwork.

    Your best bet is to figure out what happened to them and what they want to do. Don't start the conversation thinking you're going to get wiped, that's a terrible mindset.

    2Reply
  • Tim S.
    OP
    Investor · California, CA · Member since 2016 · 367 posts · 375 votes
    10y

    Thanks guys.  Yes, I understand spreading risk over multiple loans.  So to answer my question directly, it sounds like, yes.  People buy underwater seconds and can have some success with them, but they are hit or miss. Does that sum it up?

    0Reply
  • Joshua Andrews
    Lender · Austin, TX · Member since 2012 · 211 posts · 166 votes
    10y

    I have had excellent success with underwater assets. There are probably 5-7 or so viable exit strategies even when no equity is present. Despite what it may seem on the surface, a well selected 2nd mortgage with a performing first is a wonderful asset. I buy these almost weekly.

    The key is the up-front due diligence. Simply picking notes at random will get you into trouble. The due diligence process is 80% of the game, and also where the heavy lifting is. Also, recognize not all of them work out. This is why you pay a heavy discount both for the risk and the fact they are non-performing. Our company enters into the process with the goal of creating a win/win loan modification for the borrower. However, it is the borrower who ultimately decides what course of action to take. You cannot force someone to do something or take a specific action.

    A few ideas on exit strategies.

    • reinstate loan in full and have the borrower make payments according to original promissory note
    • payment plan (forbearance)
    • loan modification (my favorite)
    • discounted payoff
    • sales assistance (sell the home)
    • short sale
    • foreclosure
    • deed in lieu of foreclosure
    • foreclose, then rent the property

    There is much, much more to be discussed on this topic, as this only scratches the surface.

    Josh

    4Reply
  • Bob Malecki
    Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Tim S.:

    Thanks guys.  Yes, I understand spreading risk over multiple loans.  So to answer my question directly, it sounds like, yes.  People buy underwater seconds and can have some success with them, but they are hit or miss. Does that sum it up?

    You are correct on that Tim. Subordinate debt is a numbers game and you would essentially "cost average" your ROI based on the winners in the pool, knowing that some of the loans will not be worth pursuing. One issue I have with 2nds is that you don't know what the actual condition of that first is unless you can get the borrower to cooperate. A mod'ed first may have a deferred principal component that does not show up on the loan balance and could wipe out any perceived equity you may have in second position, for example.

    Bob

    2Reply
  • John Thedford
    Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
    10y

    @Joshua Andrews

    I would think there are not a lot of people playing in the 2nd space. I am curious if you have some idea of an average ROI buying NP 2nds?

    0Reply
  • Joshua Andrews
    Lender · Austin, TX · Member since 2012 · 211 posts · 166 votes
    10y

    @Bob Malecki makes some good points. There are ways to manage or "manipulate" the risk, but there is a significant learning curve. Instead of ROI, we use a yield calculation to determine profit. Yield is essentially how hard your money is working, or the interest rate your invested money is earning on an annualized basis. At a portfolio level, yields are quite high. I am hesitant to give exact figures as they vary and your experience may be different. I do not want to give the impression everything is a home run.

    Josh

    1Reply
  • John Thedford
    Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
    10y

    @Joshua Andrews

    Thanks. I am sending a PM.

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free