This is a transcription of part seven of our video series, Investing in Mortgage Notes. In this video, we are going to discuss what happens when a borrower defaults and what you can do.
We’re back for the seventh in our series regarding investing in private money mortgage notes. Today we’re going to talk a little bit about defaults. What happens if the borrower does default, and what can you do? What are your remedies?
Of course, it’s a terrible thing if that does happen, for both you and the borrower, but it’s something that we need to discuss, because it’s a very important. What overall happens? One of the first things that I think is important for you to recognize is that, since you are the bank, you can do a lot to help the borrower out, so he doesn’t have to default, unless he or she calls and says, “Look, some devastating thing has happened to me in my life and I absolutely can’t pay at all.”
There are other remedies. It’s not a static situation. You can always talk to the borrower, work through your servicer if you like, and say, “Tell me what your situation is.” Maybe they’ve had a medical emergency or maybe a child died, or something catastrophic, or whatever. They tell you, “I lost my job for right now,” or, “I haven’t been able to go back to work for two months, but I’m starting back in another month.”
You can always say, “All right, can you afford to pay me an extra $100 a month until the payments are current?” Or, maybe you can add those payments onto the back end of the loan, charge slightly more to make up for what’s known as the time value of money, and make two payments into three payments or four payments, so that it makes it worth your while.
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There are a number of different things that you can do just in terms of working with the borrower, to keep them in the house and to keep you from having to go through default.
Let’s say though, that that does happen, default does happen in this world. If you own a mortgage, then you have to go through whatever requirements are set forth in a given state, according to their mortgage laws. I have a network of lawyers that can handle these things in all 50 States. For mortgages of this size, it’s really quite simple to go through default, and can take anywhere as long as 18 months, or down to two months, or no time at all, just depending on what the situation is.
In some instances, the borrower will give you what’s called cash for keys, or a deed in lieu, which means that if they promise to leave the house in good condition, in what’s called broom swept order, meaning that all they have to do is sweep it out and make sure that the counters and all that are clean and nothing is damaged, you can pay them $500 or something like that, and that’s really a very good way to handle it.
For that, they sign the ownership of the property back over to you, and that’s all there is to it. Can take as few as a couple of weeks or a couple of days. If you own the property under a land contract, which if you remember, unlike a mortgage, means that you actually own, as the bank, actually own the property and the borrower has the lien on your ownership, then depending on how much money they have paid towards the mortgage, you may not have to foreclose at all. They may simply just be able to walk away. You can get their name removed from title as the borrower, because you are the official owner, and in that case, doesn’t necessarily cost you anything, and you have the property free and clear.
In terms of other mitigating factors though, I think I may have mentioned that we make conservative loans here, usually 50, 60% loan-to-value. If we have a $60,000 house, let’s say we have a 30 to $35,000 mortgage, it’s quite possible that after foreclosure, if the property isn’t in too bad a condition, that you can resell it on a reduced price basis for say $30,000, and get your investment returned entirely. You may have to put a little bit of money into it to renovate it, but again, if it was a decent market, even if it’s a slower market, and the value was 50, and now it’s down to 60, you have to think that there’s a very good possibility that you could sell it for 30, and get all of your money back.
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I also have mentioned that we do a in-depth rent-own analysis of the market, and ensure that markets are six or $700 per month, if in fact the mortgage payment is say three or $400 a month. During the term of your investment, you actually have the potential there to get paid back more than you would otherwise. Acknowledging the fact that if that’s the case, you are probably carrying some of the additional costs like paying the taxes and things like that of the property, that you would not ordinarily, but there’s a good chance that you could make at least as much money as you would during your mortgage term of ownership.
Those are a couple of ways to do it, to satisfy these. One additional way is that there are a number of investors out there, such as myself, that prefer buying nonperforming loans. Their thought is that they can buy them. Let’s say if it was a $30,000 mortgage, it’s amortized down to 25, and you can sell it to them for 25, then what they will do is, is go in, fix up the property if necessary, resell it, lease it out, sell it to another group, whatever they’re going to do.
They think that that’s a good way to make money, and it can be. It’s very labor-intensive, so you really have to be set up to do that. Personally, that’s not something that I like to do a whole lot of, because it is so labor and time-intensive. Nevertheless, it’s a good exit strategy for you.
As you can see in the case of default, I’ve just laid out four possible exits for you, for you can get your money back, that would not be available to you if you were invested in a stock or something of that sort. All of that adds to the security and stability of these investments.
That’s it for today. If you have any other immediate questions, please give me a call. I’m Richard Thornton and can be reached at (510) 918-9001. If you want to learn more, please stay tuned for the eighth in our series of investing in mortgage notes, so that you can learn more and invest wisely.
Missed our previous installments of this series? Click the links below to view them.
Part 1: Investing in Mortgage Notes
Part 2: Notes Vs. Deeds, Land Contracts, and Subprime Mortgages
Part 3: Buy & Broke Mortgage Notes
Part 4: Alternatives to Investing in Mortgage Notes
Part 5: Mortgage Note Underwriting
Part 6: Mechanics of Investing in Mortgage Notes