By John D. Behle
(This is an excerpt from the book Creative Paper Formulas)
In buying paper, one of the worries that many people have is what would happen if they had to foreclose. This month we are going to talk about some creative ways to avoid having to foreclose on someone. I'm convinced that every problem is an opportunity. When someone falls behind on payments on a note to me, we will usually both profit from it.
We've talked a lot about improving paper and one of the greatest opportunities to do so is to avoid foreclosure. Here are some ways to avoid foreclosure:
HELP THEM FIND A LOAN
With your resources and contacts, you may be able to help the payer of the note to find a loan. A small one would catch up your back payments and a large one could pay you off. You may be able to lower their payments overall by finding lower rates, offering a discount or negotiating a discount on underlying loans.
Would it be nice to be paid handsomely to help someone out. If you were paid off early or restructured your note, you would profit well. Many people that are behind in payments have lots of small loans with high rates and short payback periods - resulting in their drowning in the payments. Many times they may be sitting with a property with equity that they could put to use in financing out of some of their short term debt to lower their payments. What I do with people is look at what is termed a monthly payback (MPB). This is the ratio between the monthly payment and the amount of the loan.
For example, a $10,000 loan that pays $100 per month would be a 1% MPB. If the loan paid $200, it would be 2% and $300 would be 3%. When this is over 2-3% it can usually be improved. Many times consumer debt is around 10% or more. In other words, $10,000 might be costing them $1,000 per month when it need only cost them about $150 per month. Improving their cash flow can mean that you get paid - especially when your loan may need to be paid off for the new financing. Credit problems? It may be worth it for you to co-sign a loan or finance the property and sell it back to them on a wrap.
SUBORDINATE OR SUBSTITUTE
There are reasons you might want to subordinate to a new loan such as a raise in the payment or a partial payoff. In addition, they may have some other collateral that would work out better for you.
HELP THEM SELL SOMETHING
They may be trying to sell a car, motorcycle, motor home, etc. and you may be able to give them some direction. You may even want what they have to sell or have a market for it to trade.
BUY OUT THEIR EQUITY
You may be able to resell the property at a profit, sell it back to them or sell it to the tenant. Get them out quick. Decide what you would buy the property for and make them an offer.
HAVE THEM DEED IT BACK
If all else fails, just get them to deed it back. Let the attorneys find another line of work. Caution, Do a title report before accepting a "Deed In-Lieu-of Foreclosure." You will usually want to keep your loan in tact so that you can foreclose if needed to clear other liens on the property. This is too extensive to cover here, so give me a call if you are in one of these situations right now or in the near future. Just know that there are factors you must weight and be a aware of before taking a property back.
Here are some ways to restructure a note to profit. One way to avoid foreclosure on a note that someone is paying you on is to restructure the terms by adding the back payments to the end of the loan and changing the terms to make the note more valuable. In many cases, the payer on a loan cannot make up the back payments, but could continue to make the payments and wants to keep the property.
Option 1 - Raised Pay.
The payment can be raised a little which would increase the value of the note. It wouldn't take a large increase in the payment to make up for the amount that was added to the back of the note.
Here's an example of a $10,000 note payable $87.76 per month at 10% interest over 360 months.
Let's say that it is behind in payments by $300. If we were to buy the note at a price of $5,000 we would have just over a 21% yield. If we add the $300 to the back of the note and raise (permanently) the payments by $30 per month, then the payment will be $107.76 per month and the loan will now amortize in 191.86 months. This would increase the value of the note to $5,936.98 at a 21% yield.
Because you worked with the people, you have increased the value of the note by almost $1,000 and raised your rate of return to over 25%.
Option 2 - Graduate pay.
Let's use the same note as an example. We can even lower the payments as well as add the $300 to the back of the note. Let's lower the payment to $70 and graduate it by $10 per month each year.
Next year the payment will raise to $80 and then $90 the next year and so on, until the loan is amortized (13 years). The value will increase in this case to $5971.23 at a 21% yield - almost a $1,000 increase.
Option 3 - Lower payment
Taking the same example, what if we lower their payment to $60 per month and insert a 5 year balloon payment? The value would increase to $6960.22 - an increase of almost $2,000. If we inserted a 7 year balloon, the value would be $6178.95. We could even lengthen the balloon out to 10 years ($5338.06 value) and still make a good profit as well as helping the people out.
A FORECLOSURE AVERTED
Let's look at the other side of paper for a moment. What if you or a client are in foreclosure? Here's a success story that can be of help. A student of mine had a problem that most would consider hopeless. I was excited to show him what paper could do to help him out.
He had a property that had gone down in value substantially. The loan was now about $60,000 and the property value had gone down to around $50,000. Needless to say, people weren't waiting in line to buy his property. He was in foreclosure and worried about his credit. The solution to his problem brings about the following results.
Saves his credit Makes him $10,000 Makes an investor money Makes the property more salable Saves his banker's shirt Makes everyone real happy
The first thing to recognize is that his banker has a big problem and is willing to be creative at this point. He is facing a big loss - which he'll be excited to learn he doesn't have to take.
At this stage of the game, the banker may be very willing to sit down with you and discuss almost any alternative that makes sense. Here is an offer that your lender would be crazy to refuse!
Locate in the marketplace a $60,000 note with similar terms to the loan he has with the bank. Any total of $60,000 dollars worth of good paper will do - it doesn't have to be an identical note. Arrange for the purchase at a discount for $36,000.
Next find an investor to co-sign a new loan to refinance the property for $40,000. After taking $36,000 to buy the $60,000 note to trade to the banker and paying costs, there should be some cash and $10,000 equity to split with the investor (that co-signs the new loan) in some manner. Everybody wins big.
STEP 1 - find 60K in paper
STEP 2 - arrange to buy it
STEP 3 - trade with bank arranged
STEP 4 - refinance for funds needed to buy $60,000 in paper (for $36,000)
This is just a sampling, but I hope you can see that there are better alternatives than just calling your attorney (Vic Vicious) when someone is behind in payments. Definitely do call the attorney, but try these options at the same time as legal proceedings are moving ahead.
|© 2000Cashflow Specialists. All rights reserved.|