When entering the note investing space you need to understand the difference between a performing note and a non-performing note, and how to handle both of them.
What are performing and non-performing notes
Performing notes are notes where the borrower has been making regular payments on time, while non-performing notes are when the borrower falls behind or stops making payments altogether.
Differences between these two types of notes
Performing notes are considered higher quality debt, as the borrower is more likely to continue making payments on time. This makes them a more attractive investment because there is little work for the investor to do. Once a performing note is purchased, the investor starts to receive immediate cash flow.
Even though the notes are performing, they can still be purchased at a discount, depending on the type and value of the asset. An investor can look to pay 80 percent to par (the face value of the note), of the unpaid principal balance for a performing note.
Non-performing notes, on the other hand, are seen as a higher risk and are often given a lower value. This is because there is work involved. An investor must deploy more capital to either get the note to reperform (work with the borrower to get them to start paying), or to possibly foreclose.
Because these non-performers weigh heavily on the bank balance sheet, decreasing the bank’s liquidity, they are offered at deeper discounts. In most cases, you can purchase a non-performing note for 50-70 percent of the unpaid principal balance.
What are the challenges of both?
There aren’t many challenges to a performing note, outside of the occasional monitoring of the servicer; however, keep in mind that performing notes can become non-performing. Borrowers can fall on difficult situations such as a job loss or illness. The lender must know how to handle this situation should it arise.
The challenge with non-performing notes is that you don’t know what the situation is that made the note non-performing so you need to be ready for anything. The borrowers could be living in the house or they could have vacated the property. You may reach out to the borrowers and they immediately contact you and want to work out a way to bring the account current. They may not respond at all and you may have to proceed with foreclosure. The borrower could file for bankruptcy and you may have to wait before receiving payments. In other cases, you may reach out to the borrower and they catch up and start paying regularly. It happens. But whatever the case, the lender (you) have to be prepared for it.
Want more information? Check out our Note Investing 101 page and then take time to watch the free webinar on how to note invest.
