Frequently asked questions
What is meant by a mortgage note?
A note, in general, is short for “promissory note.” In real estate, it’s essentially an IOU in which a borrower promises to repay the loan amount under certain terms to a lender. Usually it’s monthly payments of principal and interest over 30 years. It’s signed in blue ink by the people who agree to pay the debt and is sent to the lender.
How is that different from a mortgage?
A mortgage is what ties that note to a property that someone is purchasing. It gives the lender the right to take the property if the borrower fails to keep up with payments under the terms of the note. The mortgage is signed by the owners of the property being mortgaged, usually the same as the signers of the note.
Both documents are signed simultaneously at settlement when you purchase a home or take out a second mortgage. Because the note is held by the lender, the lender is able to sell it to other interested parties. Banks often do this when the note becomes distressed because it’s easier for them to sell the note than to foreclose on the property.
What is a distressed note?
A distressed note is essentially a mortgage note that is in default. Typically, this means that the note is more than 90 days past due, so the borrowers had some circumstance that they've gone through and for whatever reason are unable to pay.
This is where 2nd Chance Funding comes in. We purchase these notes and then reach out to borrowers, hoping to get them reinstated and current on their payments. We make high returns when that happens.
Why does the distressed note industry exist?
If the idea of note investing is new to you, you are not alone. The US mortgage note investing community is a small, tight-knit group of pioneers, solving the problems created by the housing bubble burst of the late 2000s and making huge investment returns in the process.
There are billions of dollars of distressed mortgage notes across the US. We find ourselves in that position because in the 2000s, a lot of mortgage companies were creating mortgage loans that they shouldn’t have. They were giving borrowers more money than those borrowers could afford to repay. With creative financing, such as ARM loan transactions, people started falling behind on their mortgages as interest rates began to creep up. Couple that with the economic crisis of 2007-2008 when a lot of people lost their jobs, or had to settle for part time work, and the situation became hopeless for them.
Should I expect immediate returns in the note industry?
This is by no means a get rich quick scheme – working out mortgage notes is a process that requires diligence and patience. But it’s simple enough for anyone who wants to potentially get returns of over 30% to learn and succeed in. And investors who don’t want to personally do the dirty work of borrower outreach, connecting with vendors, learning nuances of state law, etc. can earn favorable passive returns.
What is a common mistake made by investors new to the industry?
What we find is some folks come into the industry and decide they want to get their feet wet by sampling just one mortgage note to see how that works out. But you really need about a year for a mortgage note to start performing or to come to some form resolution. If you're spending a whole year for one mortgage note, then you're not getting an accurate picture of what the industry could do for you. You should be buying multiple notes at a time. You will find some notes that just don’t pan out as you expected, but you'll also have some home runs that will more than make up for the duds that you purchase.
What is the main difference between buying a first and second mortgage note?
The main difference between them is that, on average, the first mortgage notes are more expensive, both in terms of purchase price and “work out” expenses to get the note performing in some way.
The purchase price for a first mortgage note is higher than that of a second mortgage, because basically you’re paying for the privilege of having the best chance of getting repaid, since the first mortgage note takes priority over the second.
When it comes down to it, we prefer the second mortgage market because we've done better from a return perspective. As far as discounts go, you can expect to pay about 20 to 50 cents on the dollar for a second mortgage note that is behind a current first mortgage. So not only are you buying it at a lower price point, you don’t have to worry about the forced-placed insurance, back taxes, etc. because the first mortgage company typically handles that.
What are some exit strategies when buying notes?
Besides deed in lieu, early discounted payoffs, and loan modification strategies, there are other options, such as obtaining the property outright to resell or rent out. However, it’s important to know there are so many unexpected turns that the mortgage note can take once you begin to work it out that you won’t know what your actual exit strategy is until the process fully unfolds.
The Golden Rule for note investing – the ideal scenario – is to do a loan modification that helps the borrower get back on their feet. Then you’ll have a note that’s bringing in cash flow every month, and you’ll also have an asset you can sell, or resell on the note marketplace for a much higher premium.
How much does 2nd Chance Funding charge?
2CF provides two services as a turnkey solution:
1) SOURCING & DUE DILIGENCE: With a minimum purchase requirement of 40k from the investor, there is a 2k per note fee that 2CF charges at the same time the purchase occurs. This fee is paid to source the notes, purchase reporting, vet the notes and weed out bad ones, roll up data into a 2 year projected ROI, and review all the collateral prior to purchase.
2) WORK OUT: From this point, 2CF uses its system to convert the non-performing notes into cash flowing notes. Upon execution of payment(s) from the note, the investor is due 70% of all money received and 2CF is due for 30% of all money received within the first 12 months. Beyond 12 months, 100% goes to the investor and 2CF breaks off from service.
What does the ROI breakdown provide the investor?
It tells the investor:
- Purchase price
- Shows all expenses based on past experience
- Provides ROI projection based on borrower repayment plan achieved in year 1 and year 2. Often times the borrower will pay towards past due arrears to get reinstated.
How much money is required?
There is an initial requirement of 40k to buy notes, a 2k per note fee paid to 2CF, plus all the workout expenses. The workout expenses vary, however it is recommend that the investor has at least $3000 in reserves per each note purchased.
Are there return guarantees when buying non-performing mortgage notes?
No. It is important that the investor understands there is an inherent risk with non-performing loans. 2CF promises to use its best effort to get a loan performing, however there are NO GUARANTEES a loan will perform. This is why we look to minimize risk and nail down a profit projection prior to buying the notes using a rigorous due diligence process.
Are notes secure as an investment?
Yes. We try to source notes whereby there is some level of equity so if we have to foreclosure, a profit will still be achieved. Again, foreclosure is the last resort after we have exhausted every opportunity to bring the borrower to the table.