Why would anyone buy a non-performing note? That’s a good question and not an unreasonable one to ask. To some it may seem pretty risky and a waste of time. But join me for this ride and explore why non-performing notes (NPN) can be a good investment.
What Is a Non-Performing Note?
A non-performing note is a note where the borrower has stopped paying. It may be due to a financial hardship, death, or they just don’t want to pay it anymore. Generally, banks will categorize non-performers by the number of months delinquent. So they will categorized them as 30, 60 or 90 days delinquent.
When a loan is 30 days delinquent, it is considered late and if the borrower has had a strong pay history up until that point, there is the likelihood they will catch up. After 60 days, they are getting close to the foreclosure timeline. By 90 days, a bank will initiate the foreclosure process.
What Are The Benefits Of Buying Non-Performing Notes?
When a note investor purchases a distressed note (or non-performing note), there is a problem that needs to be solved. As the investor, you may not know what that problem is before acquiring the note, but based on your due diligence, you will have prepared for numerous scenarios.
The borrowers may have vacated the property. They could have been in an accident that left them unable to work and bring in income. They may want to live for free and stopped paying to see how long they could get away with it (you think that’s far-fetched, but you would be surprised).
Because there is a problem that needs to be solved, you need to be compensated for your time and that compensation comes as a much larger discount to acquire the note. Instead of purchasing it for 80% of the unpaid principal balance (UPB) you may be able to get it for 50 or 60% of the UPB.
For example, if the UPB is $40K and the property is worth $80K and you get the note for $25-30K, there is a much larger profit margin.
How Much of a Headache Are You Talking About?
It is definitely more work than a performing note where you simply board it with a servicer and start receiving cash flow; however, the work is worth the return. You will need to exercise patience as you work with the borrower. You may need to work with a lawyer to go through the foreclosure process or with a property management company to secure the property. All of this can be done over the phone.
Keep in mind that you may also have holding costs while the asset is not cash flowing. There may be grass that needs to be cut or you may need to winterize the property. This is why you should always have a reserve set a side before purchasing a NPN.
Conclusion
Buying a non-performing note can be profitable because you purchase at a much greater discount than a performing note, but be sure to have a reserve for expenses and be willing to be patient because there is a process, especially if you have to go through foreclosure.
