Note investment can be a headache, especially when you have undesirable borrowers. Host Scott Carson breaks down a recent case study where the borrower paid off their loan after being modified along with the numbers behind the deal. Sharing some exit strategies for note investing, he then rounds up on cash payoffs and discusses ways you can get it in a more promising way. Learn more about how you can increase or at least get necessary cash payoffs from various assets in this episode.
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Getting Cash Payoffs On Assets
I want to talk a little bit about an exit strategy. It was probably the rarest of the rare, not quite the rarest of the rarest. With note investing, when you’re buying nonperforming notes, you roughly have ten exit strategies. One, you can wholesale the note, get it under contract and wholesale it off. Two, you try to get the borrowers performing. Reinstate the loan. Start making payments on time. Number three is you do a loan modification, a trial payment plan. If they won’t do a trial payment plan, let them assume or let somebody come in and assign the loan or assume the loan to a family member is a popular one. A short sale, deed in lieu is another opportunity we have. Another one obviously besides a deed in lieu is then to sell the house. Our worst case is to foreclose and another one is to sell the note off if you’ve done some work up onto it. If it’s a re-performing note, number nine is to sell a re-performing note after six to twelve months.
One strategy that happens occasionally, probably not quite as rare as that assumption but that’s probably the most rare is a cash payoff. What do I mean by that? That’s where the borrower owes you money and they pay the loan off. If they could pay the loan off, why didn’t they make their payments at the beginning? The thing you got to realize is everybody goes through hiccups. Everybody has financial hiccups out there. I don’t care what situation you’re in. Everybody at some point in their life is going through a hiccup. That’s the reason why most of the time they’re nonperforming to begin with that we’re looking at. They got fallen out of work, they’ve been sick, something happens, the economy shifts and they’re upside down for a variety of reasons. It doesn’t make them a bad person. If you’ve never been behind in a mortgage, you may not empathize as much as I do because I’ve been there before over a decade ago.
The thing to keep in mind more than anything else is most people want to stay in their house. Most people want to pay their bills on time. Most people want to follow through. We love to talk about the American dream of homeownership. Unfortunately, sometimes that dream turns in a bit of a nightmare. In the office, we’ve had several borrowers reach out to us to get a payoff statement. Usually, that works in a couple of fashion when we see this happening. When we get a borrower requesting a payoff statement, one, they are looking to move probably and even sell the house or two, they’re looking to get refinanced hopefully. This usually happens most of the time when the borrower’s been making payments for a few months.
Occasionally, they’ll request for payoffs on short sales and that’s not that a big of a surprise. That’s a win-win across the board for the borrower and us as well. Oftentimes, we bought that note well below what was owed, well below market value and we ended up agreeing for something close to market value to approve a short sale to get a nice chunk in. Let me give you some numbers roughly on that. Let’s say the borrower owes $100,000. The house is only worth $50,000 or $75,000. It doesn’t matter as long as it’s more than what the house is worth. If they get somebody to come and say that they were willing to pay $45,000 for the house, we would agree to reduce the payoff amount to roughly $45,000 minus closing cost.
Considering the fact that it’s worth $50,000, it’s somewhere around $20,000 to $25,000 or less for that note. If I can get $40,000 in on a $20,000, $25,000 investment, that’s a good return on investment to us. Let’s say they’ve been making payments on time. Let’s say they’ve re-performed for six to twelve months. I’m of course willing to let them get a refinance at that point. I’d be selling the house off and we’d be looking to get refinanced out after twelve months on time. The beautiful thing is it’s twelve months of on-time payment, especially if people weren’t reporting to credit before we bought the note, which we see that pretty often.
There are no derogatory negative mortgage payments on their credit so that now they can get a traditional mortgage, get out of a contract for deed if their house’s value increased or if they are looking for a traditional rate-and-term refi and closing costs on a rate-and-term refi. If you’re buying contract for deeds off on the interest rate of somewhere around 9.9% interest rate, that’s the thing you’ve got to keep in mind with that. Interest rates are usually somewhere between 9% and 10%. That’s the carrot that we like to hang in front of our borrowers a lot of times, like, “Make payments of 12 to 24 months on time. Let’s look to get you refinanced out with a traditional bank at a point.”
What we’ll often do with our TPPs, our trial payment plans, is you say, “They made payments on time for twelve months. We’ll then look at the value, recast the loan or modify the loan so that A, if you owed $100,000 and the house is only worth $50,000,” provided we bought it well below $50,000, “We’ll reduce and forgive that principal with that amount above the value the property.” Because I’m not going to capture that anyway. I’m not going to be able to sell a house for $75,000 because the borrowers of the house want is worth $50,000. That’s the extra leverage, that carrot we bang on. “You owe $75,000. The house is only worth $50,000. We know you’re upside down. Make payments for twelve months and then we’ll forgive anything over the value of the house.”
The reason I like twelve months is it gives time for that value to increase. Maybe it’s only worth $50,000 when we bought the note, but a year’s timeframe, it may get the $60,000 to $65,000 or maybe even $70,000, depending on the market. We appreciate it that much that we get added equity or profit back to our things. It’s less debt we have to give away or forgive. Another thing that happens too that I want to make sure to say, a twelve-month deal that’s non-performing, it still falls in where we can categorize it as a long-term capital gain. I can use a third party to evaluate that note as it will only be worth the $25,000 plus the payments we received.
I’m not going to get tax like what the IRS wants to tax you, “You’ve modified the loan, it’s $75,000. You’re getting taxed on that $75,000.” No, that’s not the case because we didn’t receive $50,000 of profit along the way. You bought at $25,000. You only received twelve months of payments and then it’s a long-term capital gain after the twelve months. That’s an important thing you’ve got to keep in mind. It’s why you want your trial payment plans to be at least twelve months. Never do them for three months or six months but twelve months before you modify anything. You’re not getting hit with the higher taxes aspect of it.
Anyway, coming back to getting short sales, getting it to pay off, stuff like that. The important thing is that most of your servicers too, especially if your borrower started payment on time, you can start paying a nominal fee of I think $10 a month to report to the credit bureaus. This is a helpful thing for your borrowers. I start showing it on time payments like a credit line that has 12 or 24 months of payments. It makes it easier for them to go out and get refinanced out with major banks, especially provided that the mortgage balance is going to be greater than $50,000. It’s harder if it’s less than $50,000. It’d be hard for them to go out and get a loan. They get it paid off at some credit union or something that’s going to do a smaller loan. It’s hard to find a traditional mortgage banker or mortgage company that’s going to do a loan for below $100,000. You don’t make a lot of money and I only say that as a voice of experience out there. You’re limited on the amount that you can charge total for commissions and closing costs and things like that.
Anyway, getting back to the thing. When you have lower-valued assets sub-$50,000, you often have a higher chance though of the borrowers coming back and paying you off and paying you off in a lump sum. There’s a couple of ways you can structure this. I’ve structured payoffs over 30 days, over 60 days and over 90 days. What do I mean by that? Usually, if I’m going to agree to redo a payoff and forgive some, I’m going to require them to make it a lump sum payment. Either we’ll agree to this, some of you paid off in two weeks or we’ll agree to a rolling payoff. By rolling payoff, that means they’re paying maybe a lump every two weeks or every 30 days. Let’s say they owe $60,000. We’re probably going to want to pay $20,000 one month, $20,000 the second month and $20,000 in the third month. There’ll be some penalties involved if they don’t ever follow through on an aspect. Say, “The house is worth $60,000. We want you to pay this off. You owe $80,000, we’ll forgive that extra $20,000 if you make three $20,000 payments.” That’s always a nice thing. We have a situation here right now, an asset in Alabama where the borrower owed roughly about $42,000. The house is worth roughly around $33,000, $34,000 and $35,000. That’s what he owes on it roughly. We agreed to forgive roughly $12,000 so that they can do a cash payoff.
Two weeks I reached out, I asked, “We’ve got a cash payoff amount, full payoff.” He came back, asked if we would accept $30,000. I looked at the numbers and I said, “If they are asking for $30,000, they can probably squeeze a little bit more. I said, “Let’s go to $35,000 or $33,000 before we figure out the exact value of the property and we’ll take that.” The fact that we picked that up roughly somewhere around between $10,000 and $15,000, it means we’re going to double our money basically in 24 months roughly. What was great is the borrower has been paying on time. They reinstated and started making payments on a monthly basis. It’s a good win-win to do that.
Do they owe more on their house than it’s worth? Yes, they still owed more than their house is worth, but they made payments on time. I would rather take now the long-term capital gain, take the money in, pay the investor off and then taking our profits and put it into something else. Either another asset, another investment or cashing on another investor in another deal. There are a whole variety of things we can do with that stuff, but the fact is now that we’ve been able to tap into that investment and that technically that loan equity gives us a nice chunk of change to do some stuff with.
Sending The Borrower A Letter
Here’s something you might want to consider doing to get more cash payoffs. If you’ve got a variety of notes that the borrowers owe more on their debt than what it’s worth and they’ve been paying on time for six or twelve months. You might want to send a letter out to them and say, “Mr. and Mrs. Borrower, I want to thank you for paying on time for the last six or twelve months or since such and such date. We realize that you owe more on your house than what it’s still worth. We want to talk about maybe doing a one-time sum if you are interested in paying off your loan.” “You owe $50,000. We’re willing to accept $40,000 on a one-time payoff.”
A lot of people don’t realize that you can do this as the bank. You can reach out being the bank in this situation and reach out and say, “Look at the numbers. Maybe it’s time to get refinanced out.” Of course, you could always turn around and try to sell that re-performing loan at 80%, 85% of the lesser of either the value of the property or the unpaid balance. You got to realize that most note buying companies are going to want to see a 12% to 15% return on their money. Investors sometimes want less, usually at least a 12% return over the last, depending on what they’re looking for. We’ve had some investors that are looking for a 6% return on money or looking for 8% return on money. It varies across the board a little bit.
The thing you’ve got to keep in mind here is if you can get them to come to do a cash pay off with it, you’re going to get the highest dollar amount versus only taking 88% or 85% because that’s what the fund’s looking for. That’s the thing to keep in mind. That’s an opportunity. That’s something you can think about. Send a letter like, “We’d like to offer up a one-time reduction in debt if you come to the table in the next 30 days to pay off.” Some people will take you up on it. Some people are like, “No, I can’t do that.” That’s fine but you never know if they want to go cash out there. Some people have IRAs, some people have 401(k) and some people will have friends with a family with the money they can get paid off. Some may have a relationship with a bank that they go in and get a line of credit or be able to get a rate-and-term refi on that for the most part. That’s one thing to think about too as an exit strategy.
If you’ve got a bunch of assets, take the time, look at the payment streams, look what’s going on and a dive into what borrowers might or might not be able to do it. It’s a simple letter. Pick up the phone and make a phone call. You may want a draft to do a mail merge and identify the assets of your portfolio. We were doing this specific thing. We’re going to identify the assets that have been performing and we’re sending out an email for those that we have an email address for the borrowers but otherwise, there’s a direct letter saying, “We’re willing to offer it this one-time settlement to pay the loan off. We know you owe $50,000. The house is only worth $30,000 or only worth $40,000. We’ll accept roughly coming in at 95% of the as-is appraised value.”
That way they’ve got a little bit of room there if they need a roll in the closing costs or things like that to get it done. It’s a powerful strategy. Not a lot of people do it. A lot of people get excited because it’s like winter in June or July in the middle of the year when you get a cash payoff like that. It’s a great thing. Some people don’t want to have that happen, but it’s bound to happen with the portfolio. Because people are going to buy and sell, they’re going to move. They’re going to a variety of things. Oftentimes your borrowers, people that buy a house are going to move once every five to seven years. It’s not quite the case if they’ve lived in that house for 30 years but it is okay. We’ve had the same thing happen too when somebody wanted to get out of the house. “I got somebody wants to buy the house.” “Let’s get him qualified. We can originate a new loan. You will need to get a license and a low mortgage loan originator to create that new loan or the new contract for deed,” or whatever it might be.
It’s going to be an amount that’s going to be as is the value of the property. The borrower’s going to have to bring some new borrower’s going to bring something down as a down payment, 5%, 10%. I prefer 10% or greater, depending on the situation. The way I like to structure these deals is I prefer doing the first lien 75%, 80% and a second lien at 10%, 15% of LTV. That way there’s a first and a second. It’s structured. I need to get that first off, close to par, and then we get refinanced that close to par on that stuff. If I’m the bank, I’m not doing a loan at 5% or 7% or anything like that. I’m still going to do a loan at 8% to 10% of interest rate because I’m the bank and I’m the one that’s carrying the paper. I want to make that note as attractive as possible in the long run for somebody else to take off my hands. It’s a little of a haircut as possible out there. That’s the thing you’ve got to keep in mind. Cash payoffs can happen when you start getting payoffs.
I’ll give you another example of a scenario. I’ve got a condo in Delray Beach, Florida. The borrower owes a chunk of change. It’s a two-bedroom and two-bath. It’s funny that the HOA did the foreclosure subject to the first lien. I hold the first lien. The pay off on this one in Delray Beach, the unpaid balance is $33,000, $32,901. They owe $49,000 as the payoff. When you look at back taxes that we’ve paid, 101 months. It’s a lower-valued asset. The thing is we knew got hit in an area that took a big hit and we’ve been waiting for the value to come back up and the value has come back up, which has been nice. The value of the asset, based on what realtors are telling us, depending on the interior conditions, is somewhere between $50,000 and $100,000. We’ll say it’s $75,000. Suddenly I get an email request from a title company for a full payoff on this unit. I looked at it. I filled the number and sent it in and then suddenly later I get an email from the attorney for the HOA. They had done the subject to foreclose. They’ve already gotten rid of the borrower and they’re basically like, “We would like to negotiate some deed in lieu. We’re going to deed it back to you if you make a chunk payment to the HOA.”
You got to realize, this is a condo note in Florida. If I foreclose, all I need to pay to foreclose is going to be usually the lesser of 1% of HOA fees or 1% of the regional sales price of the HOA fee or one year of HOA fees. Let me restate that and make sure I didn’t goof that up. I’m going to pay the lesser of either 1% of the original sales price or one year of HOA fees, whichever is less. Finance was roughly less roughly about $50,000 on this note. The sales price is roughly $50,000. That means I’d be paying $500 HOA fees according to the Safe Harbor Laws of Florida or one year of HOA fees. We can all agree the HOA fees are going to be a lot higher than $500.
What was funny is the attorney was like, “We’re glad to do it, but the borrower owes $7,000 in back HOA fees.” I’m like, “I’m not going to pay $7,000. If I foreclose, it’s going to cost me $500 roughly for Safe Harbor plus my attorney fees.” What kind of condition is the property in? You guys have been writing it. If you’re threatening to start writing it, it tells me you’re not writing it right now. I know it needs some work, but I’ll wait on the value to come back up, which it has.” We knew the HOA was foreclosing, so I’m not going to speed up the foreclosure.
I’m going to wait, let the HOA do the heavy lifting to get rid of the borrower in a junior lien position subject to mine. They’ve done all the work. I could go come to say, “I’ll pay you $2,000 or $3,000.” Maybe I’ll pay him a half, $3,500 to the HOA for half of what you’re owed. Take the condo back, turn around and sell the asset off at that point or start making HOA payments and keep it as a rental. The one tricky thing about this asset, it’s in a 55-plus community. I couldn’t move into it. I couldn’t rent it. I don’t know if I could rent it, but it’s got to be 5- plus community. I’ve got to look at the bylaws of the HOA.
This was part of a bulk portfolio we bought a while back. It’s a lower-valued asset. I’m not going to spend a bunch of money to take an asset back that I can only sell-off. I’m just going to let this sit one sit and ride for a little bit. It’s something we bought with our funds. We’re now at a place that I’m pretty excited about it that we’ve got this asset sitting there. We’re going to go through the HOA who’s done all the heavy lifting. Maybe we come back and say, “We’ll offer you a $3,500,” start painting HOA off. I’ve already had five realtors reach out to me when I posted it in a Facebook group in South Florida real estate who sent me CMAs who are interested in getting involved. Some of them already have existing listings in the area, so that’s what I’m trying to look at. It’s like, “How many listings are in the area,” to help us with what our exit strategy should be.
The HOA isn’t in a position to sell the asset because of my payoff. The borrowers owe $49,000. It might need a little bit of work. It’s not too bad, but it’s a great area of Delray Beach. I’ve owned some other units in the same complex or nearby that we’ve made some good money on. This one we’re pretty excited about as well. Doing a cash payoff is not a bad thing. Would I accept $35,000 on a sale on this one? I’d accept $35,000 if the HOA wanted to try to sell it and I reduced my payoff to $35,000. I’d knock $14,000 and $15,000 off knowing what I paid for the note early on was somewhere around $10,000.
There are some great opportunities in cash payoffs that can take place in your note business. You’ve just got to know how to structure the deal or how to wait and see sometimes works in your favor. Especially when we took such a big hit years ago, I didn’t want to rush through some of these deals because if I rush through, then I’ve got to take an asset back. Can I turn it into a rental? Yes, but I don’t know if I want to. Let it sit there, pay the taxes a little bit and wait, knowing especially when we’re getting notes with HOA on the condos. A lot of condos that we bought, the HOA is doing the heavy lifting. I’m like, “I’ll just let them do the heavy lifting and wait for a little bit or wait and see what the values come up.”
Another asset we did is we end up getting a large tax overage of $75,000. What’s that mean? We were into the note for $20,000. It’s a desirable area but it needs some work. People think about Florida as most of the foreclosures are you can see online. This is what happened. He got bid up to $90,000, $95,000 at the tax auction, which is great. The back taxes got paid to the county, the state, and we filed the tax overage claim because we were the first lien holder behind the taxes. We got a check for $73,000 to us on that deal, which is a 300% return on our investment. That’s a good deal.
The thing you got to realize it it’s not always black and white as far as going, “I’m going to foreclose on this so I want it modified.” Sometimes you look at what’s going on with the asset. Every asset has zones. As I would say, country-western song. If you look at the deal, look at the asset, look at what’s going on in the area. Look what’s going on in values and if values dropped, but you know it’s an area that’s going to rebound back, sometimes it makes sense to sit and link for a little while. Wait for that asset to rebound, to increase in value and then go from there.
Cash payoffs are great. One of the things you always do want to keep in mind too is just because you get up sitting in a payoff doesn’t mean it’s going to happen. Sometimes you have to follow up and say, “What happened with this deal? Who requested the payoff? Is this asset trying to be sold? Is it in a foreclosure? Somebody besides the first lien holder, whether it’s me or our company and then go from there. I love cash payoffs. They’re great. Now you got to take the money and double down or do something with it and put it back to work. That’s the one, the most important thing is reinvesting. We’ve done a lot of that, taking our profits and reinvesting back into our assets or to new deals to take advantage of the market because I still believe that the note business is one of most profitable businesses out there.
Look at all the people out there in the REO space that are clamoring and saying, “I can’t find any deals. REOs are at $0.70 on the dollar or less. I don’t want to overpay for wholesale stuff.” Notes are still a great way to make money because the fact is the values are there and you’re buying that debt usually below $0.50, $0.60 on the dollar up there as well. Any questions, feel free to reach out to me. If you’re looking for deals, pull out your smartphone. If you’re looking for deals, text the word DEALS to the phone number 72000 and send a text message. If you got the ability to send it, you may need to adjust to the AT&T as a setting on their phones. They don’t want an incoming text message. You may have to do that. Anyway, for the rest of the Americans, text the word DEALS to 72000. I’ll send you the link to opt into our website. Opt-in one of our things. As we get deals in, it’ll ask you to pick your three favorite states. As we get deals in those three states, we’ll be glad to send you a list of those that you can take a look at, cherry-pick from and go from there. Go out and make something happen and we will see all at the top.