Please explain a basic concept to me: Equity

[Jeff L.]

I've been reading the basics of note investing, and keep coming across people recommending buying notes that have a lot of equity. I don't quite understand it and was hoping you guys could explain it to me (I'm sure it's a really basic concept I'm just missing).

How does equity come into play in notes investing and why do you care about it? When looking at purchasing a note, why does equity matter?

Aren't the numbers you care about mainly 1) the price of the note and 2) the as-is value of the house (the price you'd sell it at in case of foreclosure)?

Some basic examples with numbers would be amazing. Thank you!

[Patrick Desjardins]

Originally posted by @Linda Hastings:

@Patrick Desjardins @Joshua Andrews Thanks for the detailed answers! I have a couple of follow-on questions...

If there is a lot of equity in the property, why would a bank want to sell the note? Why wouldn't they just do a foreclosure and get paid off the balance of the loan? When they do sell these type of notes, are they more likely to want a higher price for them?

One other thought...is the borrower more likely to fight you on a foreclosure when they do have a decent amount of equity in the property?

 Great questions, so let me take them one by one.

Why would banks want to sell the note? A LOT of these NPNs haven't been originated by street corner banks. They were originated in massive quantities and securitized then sold to institutional buyers who have no interest in managing foreclosures and holding real estate. These guys trade assets all the time, whether they're performing or not, which is why it's pretty common to get 4+ assignments AFTER it was taken out of MERS. On a lower level, the smaller funds that buy these in bulk and resell to newbies keep some notes and sell the rest to recapitalize. Some of them post on this forum.

Yes, since that's what everyone wants to buy and there is more upside, notes with equity sell for more. For example a first mortgage where the UPB is 100k and the house is worth 200k will sell for more than a house where the UPB is 100k and the house is worth 50k, which of course is common sense.

As far as borrowers go, I think there is a small correlation between equity and combativeness but it's more of a problem with 2nd mortgages than firsts. The vast majority of borrowers don't understand anything about the system. They aren't the ones who are going to fight you on a foreclosure because most of them just bury their head in the sand and pretend it's not happening. 

However, combativeness is mostly about whether they hire a specialized attorney or not. And low equity borrowers love their bankruptcy attorneys. Borrowers who represent themselves usually are the easiest because they have no idea about their rights or their options, but if you're a fair person you can lead them toward a win-win scenario. The borrowers who hire a run of the mill attorney, which happens a lot in situations where they went into default after a divorce so their counsel is a divorce attorney, are also pretty easy. The attorney knows enough to recommend their client to work with us, but they're not going to look through the paperwork and find a flaw with it. They also don't (in my limited experience) recommend complex delay tactics like filing multiple bankruptcies etc.

The problem comes from specialized attorneys, the ones that advertise and advocate stuff like foreclosure defense, bankruptcy etc. If your paperwork is in order you'll win but they will delay your foreclosure and cost you more money. They don't typically encourage their client to work with you, either.

I don't know if that answers your question at all but I always get long winded when I start ranting about the crooked attorneys in this country :P