Real Estate Note - Borrower constantly late, ideas?

[Peter Lambert]

Hi everyone - first post here after visiting and reading the forum for several years. Looking for advice on a deal I'm already in on. I'll try to be as concise as possible.

Loan is in the State of Texas. 18 months ago I refinanced a home for a neighbor and acquaintance facing foreclosure. I paid off the previous lender, and loaned the borrower approx. $95k on a house that I felt very confident would fetch $225k-$250k in a distressed sale or foreclosure. Interest rate 5%, 30 year amortization, 5 year balloon. Much more favorable than hard money rates in the area, and I realize now the predicament loaning $ to friends or neighbors put you in. That being said, I used real estate attorney in the area, the note is secured by a deed of trust, and I have the first and only lien. Loan to value ratio was a big part of the reason I did this, and the fact that two years ago, getting 5% for 5 years didn't seem too bad, especially with the equity cushion in the home.

Surprise, we're 18 months into the loan and things aren't looking that great. Borrower has been late and behind multiple payments for the majority of the mortgage payments. Taxes aren't escrowed, and I had to pay the 2012 tax bill (a little over $5,000) in January 2013. Borrower is currently two months past due, one year of taxes past due, and doesn't have anything socked away for 2013 property taxes due in January 2014.

I welcome all advice and suggestions moving forward. Before you criticize me on how bad of a loan this is, consider the following...

-House directly across the street just sold for $400k (same sq. ft., though recently remodeled).

-Neighborhood has had considerable price increases in the last year and houses are generally pending in under a week.

-Current outstanding balance is a little over $100k on a house that I think would fetch $250k-$275k in a fire-sale situation.

-Interest rate on overdue unpaid balance is 10%, compounded monthly.

-If the previous 18 months are any indication, my guess is borrower does not have the means to make any progress on current overdue balance, and will add $6,000-$7,000 each year to the overdue balance (Tax payment of $5,500 and one or two missed monthly payments).

-I'm in my early thirties, borrower is 57. For all practical purposes, this is sort of functioning as a reverse mortgage. For every missed mortgage or tax payment, borrower transfers equity in the home to lender.

Questions for the people on the forum:

1. Should I just cut and run now? Borrower has shown no indication that he will be able to make timely payments. This will more than likely involve a foreclosure process. Things could get ugly, and I'm almost certain borrower would file bankruptcy if I foreclosed. What is the cutoff limit, in % terms, those of you who have experience in these types of situations, to start the process? Example, if house would get $275k in foreclosure, do I wait until unpaid balance is $150k?, $200k? This is before legal expenses. How much should I budget for legal expenses associated with the foreclosure process?

2. Or should I take the long-term approach? Any additional money that I pay (annual property taxes) gets added to matured unpaid principal balance at 10% and compounds monthly. Over the course of 5, 10, 20 years, there could be several hundred thousand dollars worth of equity in the home.

3. I speak with the borrower regularly and have talked with him about additional employment ideas, and have suggested he just sell the house. He would pocket anywhere from $150k-$200k on a sale depending on how much work he is willing to put into it.

4. When I first drafted the note, interest rates were historically low. There have been pretty substantial moves in the 10yr in the last several months. I'm glad this note has a 5 yr balloon, but should I push to increase the rate now if he wants to continue? Language of the note gives lender the sole discretion to extend for an additional year, each year after the first 5. I was thinking of amending the terms of the note to 7.5% if he wants to continue and use the threat of foreclosure as leverage. Thoughts on this idea?

5. Should I require borrower to escrow taxes? He likely won't be able to make the payments, but this would increase the matured unpaid balance faster than paying one annual payment.

I welcome any other ideas or suggestions. One thing I'm not really willing to do is sell the note. I'm leaning towards moving on it quickly (after about two years of late and delinquent payments) or riding this out for the long haul.

Thanks for your time and input.

[Ann Bellamy]

My answers don't take into account your personal relationship with the borrower, because I don't know enough about that, and it may be impossible to salvage anyway.

First, although you appear to have a significant equity cushion, it is amazing how quickly that can change. Accrued interest and late fees, unpaid taxes, unpaid insurance, (have you checked?), deferred maintenance, possible retaliation damage, legal fees for foreclosure, more legal fees because he declares BK, changing market conditions, yada yada. So I would NOT recommend riding it out.

The second consideration is whether your loan is in compliance. While you may have had an attorney draft the documents, if he is not well versed in private lending in your state, you may have violated multiple lending laws. First and foremost would be the SAFE act, implemented in 2009, which requires that residential lenders be licensed. If the TX version of the SAFE act requires that, you may have trouble foreclosing if he pushes back. I find that regular real estate attorneys that don't deal with private lending are unaware of the SAFE act requirements. I don't know TX law at all, so you need a TX attorney very experienced in private lending.

So no, I wouldn't wait, I'd act now, and I'd first consult a TX attorney specializing in private lending. There are TX investors here on BP that do private lending and they should be able to help you find an attorney. Of if you know all that and are sure you are in the clear, I'd still not wait. Time is not on your side. Just my opinion.