All Forum Posts by: Eric Jones

No, you wouldn't be over-leveraged. Each property would have an LTV less than or equal to 70%. You'd need to be smart about maintaining adequate liquidity though. As long as you have liquidity, no, you're definitely not over leveraged.

@Taylor Dame - the LOC rates you were quoted seem quite high. You should be able to find a bank that can do a secured line of credit or a HELOC @ about Prime + 2-3%. Check out TD Bank, they offer HELOCs on investment properties.

The advantage to a line of credit is flexibility, but the trade off is exposure to a rising prime rate. Since we are currently in a rate tightening cycle, you should plan on rates adjusting upwards somewhat. The only way I'd really recommend a LOC for this purpose would be if you intend to make interest only payments. This strategy has more inherent risk, but if you know what you're doing it might be a smart move (also ***

But it sounds like you're looking for long term leverage, and for that, a LOC isn't ideal. For that, I'd do a cash out refi @ 70 or 75%. 25-30% of an equity cushion is plenty, assuming the property generates strong cash flow.

I'd avoid the 1031 route - when you sell the property, who's to say that you'll find another good investment within the 6 month window? Since RE prices are high currently, you may have a hard time finding a better investment property than the one you just sold. 

@Dillwyn Mathurin

@Dillwyn MathurinI think you've misunderstood. I'm not saying that he should hope for someone to default on a rent to own contract. I'm saying that it's a protection mechanism for the investor, and is one of the perks of doing rent to own contracts. 

I agree that Greg has a valid point. I think a straight sale is a good option as well. @Shawn Wilson wrote this post to hear about other ideas that he may not have considered thus far. I'm just presenting another option. What he chooses should be a function of his risk tolerance, time frame, goals, etc... not based on what we say here. He seems like an intelligent guy, so the notion that a rent to own contract is too complicated for him and has too many moving parts is unfounded. They are in fact very simple and are not something to be scared of. Either way, I think Shawn is on the right track... it's really a win win scenario for him and at this point it's a discussion of the optimal decision for his particular situation. 

@Wayne Brooks

Agreed. The FMV is $145-165K. Senior is at $64K and junior is at $63K UPB, so there's plenty of equity. It also happens to be in my hometown and the property can easily rent for $1500-1600. It;s a nice neighborhood and one of the top school districts in the nation, so it would sell or rent very quickly. Did a drive-by yesterday and it's a house that I'd be happy to own if I had to foreclose. My preference would be to work with the borrower to help them stay, if that's what they want.

I'll be calling the New York Attorney's office to make sure that the UPB and arrearages are collectible considering the statute of limitations that we discussed.

Thanks for your help guys!

Sorry, I misspoke when talking about lien stripping. As I understand, if a lien is stripped, it is no longer attached to the property, but you can essentially still go after the borrower for the unpaid amount. Still, I could use some clarification on how a stale note can go from secured to unsecured... this seems like a major risk and haven't heard of something like this happening aside from a Chapter 7 bankruptcy. 

@Dion DePaoli

Gotcha. This helps clarify things a lot. 

I think you misunderstood me, or perhaps I didn't explain myself well. I do understand that interest incurred is a function of loan balance, interest rate, and compounding interval. I used one specific data point (UPB = $64K) just as an example. I'm not assuming that the interest is constant every month as you stated...

What is interesting about what you described is that the interest owed over the defaulted 60 months is the interest that you would have received had the loan been current. But that interest is not getting added to the loan balance or being capitalized, so the UPB has stayed the same.

In terms of "collections" it sounds like the note is considered to be "in collections" for the entire default period, regardless of whether there are outreach attempts made by the note holder or servicer. This makes sense. What doesn't make sense to me is how a SOL on the collection period could cause a secured note to become unsecured. At the end of the day, the borrower signed a promissory note for X and the lien on the property would exist unless a court mandated that the lien be stripped. In the case of a stripped lien, wouldn't the lien still be attached to the property, but not the borrower, similar to a Chapter 7 lien strip? So I could then foreclose on the property and the borrower would have the option to make the loan current, do a workout/modification, or move?  

Thanks a lot for running through these numbers for me, this really clarified how the interest and late fees are calculated and added to the UPB to give the payoff amount.

@Bill Gulley

Thanks. So are you saying that this note is "stale" simply due to the fact that it's been in default for five years? Most of the tapes I look at have notes that haven't been paid in 5-10 years. Would you consider all of these notes to be stale and therefore unsecured/trash? 

I certainly wouldn't want to purchase a non-performing junior lien and then find out that it is in fact unsecured. The whole investment strategy with non-performing juniors hinges on the fact that while the note is non-performing, it is secured by the underlying property. 

In terms of your APR comments, are you simply saying that a defaulted note accrues interest on a daily basis (using 360 days per year) rather than monthly? This won't change the end result much at all as you're only changing the compounding interval, but it's a good thing to understand.

Lastly, thanks for the pointers on the importance of obtaining servicing records even on a non-performing note. I'll make sure that I request that as part of my due diligence. 

@Greg H.

I think we're just talking about another method of selling vs the traditional method of going through a realtor. Couldn't a 1031 exchange also be used to defer taxes if the house is sold via a lease option? If so, the only advantage of selling now would be the velocity of money... but if you are patient and willing to do a lease option you have more upside potential with the down payment, the ability to sell for 5-10% above the market price, and not having to pay 6% to a realtor. What am I missing?

@Shawn Wilson

I've heard of some sellers that apply a portion of the rent payment to principal reduction. So they are essentially getting some equity each month. But more often than not, the people I talk to do not apply anything to principal reduction, since it can become an issue if the tenant/buyer defaults on the LTO agreement. For example, they may put down $5K, and make monthly payments on time each month, but if they fail to obtain financing within 24 months the contract is terminated. In this scenario the tenant/buyer could potentially take you to court on the grounds that they now have an equitable interest in the property. The outcome would then be in the judge's hands. While it may be possible to allow principal reduction, a lot of people avoid this to prevent a tenant/buyer taking them to court over equitable interest after a default on the contract. 

I think you hit the nail on the head when describing the best case scenario. 

@Dion DePaoli 

@Wayne Brooks

Thanks. A couple comments:

I will certainly look into the statute of limitations issue that you mentioned. But I just want to clarify that being in default on a loan doesn't necessarily mean that the loan is in collections, right? So it could be totally feasible that the loan has been in default for five years, but has not been in collections for five years. I would think that the status of limitations would only apply to collections efforts, not to length of delinquency... I would also think that should I acquire a note that has such a statute, I could simply perform the state-required borrower outreach and then initiate foreclosure, right?

It sounds like both you and Wayne are in agreement that interest continues to be incurred on the loan balance when the loan is in default. However, you also state that negative amortization doesn't occur. I presume this means that although interest continues to be incurred, the interest is not capitalized to create a new, larger interest-bearing balance?

In terms of my interest calculation I'm essentially just using the following equation:

FV = PV * (1 + r)^n  

where FV = future value, PV = present value, r = the interest rate per period, and n = the number of periods

So using this, for the $64K balance @ 13.75% APR, after the first missed payment the new balance would be:

FV = $64,000 * (1+(.1375/12))^1 ==> $64,733.33 (or $733.33 in interest has been incurred)

Since you're saying that negative amortization/capitalization doesn't occur, I'm assuming that means that for each successive month in default the loan will accrue an additional $733.33 in interest. Or, said differently, you continue to accrue interest only on the $64,000 balance, NOT the $64,733.33 balance. I'm also assuming here that the 2% late fee isn't capitalized and is a fixed $17.34 per month whether it's one month late or one hundred months late. 

Some more clarification on the math of this would be helpful. I will certainly see if the seller can provide this information, but I don't see any reason why I shouldn't be able to calculate arrearages and payoff amount on my own with the information that I have.