Valuation of 2nd Lien After Brought Performing

Valuation of 2nd Lien After Brought Performing

Livecast #


Learn how to calculate the increase in value once your 2nd lien has become seasoned as a performing loan.

Ron Happe: Are we running? Good morning everybody, welcome to our Tuesday live cast.

Unfortunately, we were gonna try to have Sabrina on here today also via Skype, but she was unavailable this morning, she had a doctor's appointment. So, too bad, you're stuck with me.

Today we're gonna cover a couple of questions, they have a little bit to do with last week's due diligence, but they expand the business a little bit. And I wanted to address these topics because a lot of people that are on our live casts are not really involved in the second arena. Some of them may be buying firsts, some of them may be taking a toe in the water type attitude toward getting into seconds.

And we had a good question from Manny Sanchez, and Manny's question had to do with the valuation of a second after its performing. Or what can you expect to get for a second after that second has been performing.

And one of the important things for everybody to understand is that this business is a business that you learn by doing unfortunately. I've compared it golf before, you just cannot read a book and expect to go out and play golf well. You need to play the game and you need to practice. The same thing, and by the way I wasn't at a Super Master's tournament this weekend, unbelievable.

Anyway, back to the seconds. The only way that you're gonna feel comfortable and really learn this business is by doing it. And the sale of a performing second note, you will learn based upon the people that you have as your buyers, and that's something that you will have to develop as you go along, is a buyer's list. Or you're gonna have to use some of the MLS loan services, sales services that are out there on the internet to market your notes.

You're gonna learn what the industry will pay and you're gonna find out what the industry is going to pay on your particular notes and how well you've worked them out and so on. But I do want to answer Manny's question as thoroughly as I possibly can because it is an important question it runs into the same topic of why do we get into seconds in the first place, as opposed to firsts. And I think it'd be very evident to you what the possibilities are with a second versus a first as we go through this.

So I think what we wanna do first is, I just want to make up a scenario of ... Just come up with a scenario of a note that we're going to purchase. This would be somewhat of a typical purchase for us. The original note was for 82,500 at seven and a half percent for 300 months, or 25 years. If you do an amortization, and I think that's something that we should probably do, because you want to check everything that you purchase.

So this one here is for 300 months, that goes under the "in" column. We said it's a 7.5 percent interest rate. We said that the present value of that note, that when it was written, was for 82,500 dollars. And it's a fully amortizing note, means that at the end of 25 years or at the end of 300 months the loan is gonna be paid fully, so there is no future value, the payment then would be, $609.67. And that's what we have here. The original payment is $609.67.

We're also going to assume that this note was paid for 48 months. And we want to determine, what is the unpaid principal balance if it were paid for 48 months. So we're simply gonna add 48 into our note category, the original sum was 82,500, what's the future value after 48 months? 77,259.69.

Alright, so, here's something that you're going to be confronted with. On your HP calculator, you could get two different totals when you do it two different times. Or you and somebody else could be using two different calculators and do this thing, do this problem right here and you're gonna end up with a little different pricing. And that is just calculator error and it's not uncommon.

So we're buying a note that has an unpaid principal balance of $77,256.56. And this is a typical note for us, our average notes are approximately $70,000. So this would be a typical purchase. And let's say also that we pay $11,588 for this note, which has an unpaid principal balance of $77,000 plus.

Let's also assume that the note that the homeowner has not paid in 34 months. So arrears is simply taking the 34 months that they have not paid and taking it times the payment of 609 ... comes up to 20,728.78. Now, granted there's gonna be some penalties and interest on this, probably $25 a month late payments or so on that you calculate into this also, but we're just gonna say the arrears are 20,728.

So you go to work on this note or a workout specialist goes on to work on this note, and the homeowner wants to stay in the home and agrees to pay 4,000 of that 20,728 in arrears. So the workout specialist puts the following workout schedule together. "Mr. Homeowner, if you'll pay us $4,000 of the $20,000 arrears and pay $425 a month as your new payment, we'll reduce your interest rate to 4 percent. And, if you pay this on time for two years, we will reduce the arrearages and eliminate the $16,000 additional that you haven't paid. So we're just gonna wipe those out and we're gonna reduce your interest rate almost 50 percent down to 4 percent."

So the first thing then that we have to do, is we have to determine ... Now remember, what we're trying to do is determine how much do we think we can make on this when we sell it. So now we have a workout, what we need to know now is, how long will it take, at a new payment of 425, this should be 425 instead of 609, sorry about that, made a mistake there, I didn't put the new payment in. Payment should be 425 at 4 percent interest, and we want to pay off this note of 77,000, so we have 77,000, we have 77,254 as the unpaid principal balance, our payment is going to be 425, and that is a negative. And our interest rate is going to be reduced to 4 percent. And we're gonna solve ... Oh wait, future value is zero because we're gonna fully amortize this out.

So how long will it take to pay off $77,254 at $425 a month, 4 percent interest. So we're gonna solve for N. 279 payments. So, if we take monthly payments for 286 months, and let's say we season this note for only one month. Now, we have investors who will pay to buy a second that is performing after the first payment provided that there has been some kind of a payment made on the arrears.

So in this case, the homeowner now has $4,000 into the game, and they've made one payment of $425. The investor, to take the risk of this note, will pay an amount that will get him a yield of 20 percent. So if we have six payments at, he wants 20 percent, he's gonna get $425 a month, what would he pay in order to get that 20 percent yield? He would pay $25,274. How likely is that to happen? It depends upon your buyers list. It would be somewhat likely for us to be able to sell that note at a 20 percent yield to the investor. Whether you have that list of buyers or not, I can't tell you.

On the next one however, I'm fairly confident that anybody could find a buyer for this. So let's take a look at this one. We have a note that is seasoned for six months. So they've made six monthly payments and now we're going to sell this. And we are going to offer our investor, who's buying this note, an 18 percent yield. So how much would we sell it for, for the investor to get an 18 percent yield?

Well, let's do it, alright? So, we have 286 ... Well actually on this one here, now we're down to 280 months because there was six months of payments made. So, if we started out at 286, six have been paid, we go down to 280. Our interest rate is going to be 18 percent. That's what our investor wants to purchase this note. The payment remains at 425. So what would an investor pay to receive an 18 percent yield on $425 for 280 months? He's gonna pay 27,895.

Alright, again, we have just a little bit of an error here, and that's common place. That's nothing to worry about, it's calculator error. So in this case, we've kept the note paying for six months, the investor feels more comfortable about it than they did on the one that had only seasoned one month, so therefore their yield expectations are a little bit lower and we get more money for it.

So now let's take a look at one that is seasoned for 12 months. And this one here ... Very easy to sell, very easy to sell. So, in this case, again, we've paid for another six months, so now there's only 274 months left. The yield to the investor would be ... We're going to offer 15 percent. The payment remains at 425, what would that investor pay for a 15 percent return on $425 for 274 months?

Well, let's do that again. So, we have a 15 percent return, we have 274 months, $425 still is our payment, what would the investor pay, or what is the present value of that, 32,869. 32,869. So the investor would pay 32,869 for that note. Now, you as the purchaser of the defaulted note needs to make some decisions. Do you want to try to sell this note with a 20 percent yield and one month of seasoning? Do you want to try to sell it at six months of seasoning and ... (silence) ... yield, and collect 32,869, which is approximately 6,500 dollars more than you would have gotten if you would've waited.

Well, in order to make an informed decision, it's probably best if you were to do a annualized return on investment on this property or on this note. So if we do case one, which is we collect one payment and then sell it, and let's make another assumption, let's say it takes us nine months from the time that we buy this not to get that one payment behind us and sell the note. So it's gonna take us nine months from the time we ... (silence) ... $425 worth of income, which is the result of a $4,000 arrears payment, plus 425 in one month's payment. And we saw from our calculation that we were gonna sell this note for 25,274 to return the 20 percent yield to our investor.

So the total that we collect on this note is 29,699. The amount we sell it for plus the amount of income that we've generated during the time that we owned it. We paid 11,588 for it, so we have a profit of $18,111 in approximately 10 months, nine months to work it out, one month of collecting income, so we've got 10 months. So we get an annualized return of investment of 187 percent.

Case two, we've received 2,550 in payments. 425 for six months, $2,550, plus our 4,000 in arrears gives us a total income of $6,550. From our calculations, to return to our investor 18 percent, we're gonna sell it for 27,274. Or a total of 33,824 income during this period of time that we held the note. The period of time that we hold the note in this one is six months longer than we held it before, so now we're at 15 or 16 months of holding this note before we sell it. We still paid 11,588, our profit is 22,236, or an annualized return of 158 percent.

So, you've gotta weigh the difference between 158 and 187, and as soon as we look at scenario number three, I can give you a little more insight into what our decision might be.

So the income in case number three, the homeowner pays us for 12 months. And then we sell it. So they are paying us total payments of $5,100 plus their $4,000 in arrears, which gives us a total income from the period of time that we owned the note of $9,100. We sell the note for 27,935, for a total of $32,869 worth of income off of this note. Again, we paid 11,588 for it, which gives us a profit of $21,281 over the period of time that we've owned it, which annualizes down to 158 percent return on our investment.  

So now we have 187, 158, 158, and again it's gonna be determined by how long are you comfortable holding the note to sell it to an investor that you have found. And what we're likely to do is keep it for ... We're likely to keep it, I'm trying to get back here.

We're likely to keep that note for six or nine or twelve months because we would warranty that note to the investor. So we want to be sure that we have a note that is going to continue to perform. And usually our history has been, that if a note performs for six months or twelve months, but usually just six months, if it performs for six months, the likelihood of it going to default again is very, very slim.

So if we're going to warranty it and we don't want the hassle of taking a note back or working it out again, then we definitely want to keep it for six months. Now, we will sell notes that have one month seasoning on them to investors that are comfortable buying those kinds of notes. It becomes a decision that you make with experience, and you need to decide at that point, just what you're looking for from you investment.

If you don't have a large staff that can do workouts, and you get a note back and it puts you into a jam of working notes out, that can be a problem, so you might want to wait and collect the funds. In addition to that, you may be a cash flow investor, where you want to keep that cash flow. If you're collecting $425 a month, let's just do that real quick, if you're collecting, let's clear these out, if you're collecting $425 a month, times 12, this $5,100 per month that you're collecting, you paid 11,588, you are collecting $4,000 in arrears, you only have $7,588 in this note and you're collecting 5,100. So if you divide 5,100 from 70 ... whoops ... 67 percent annualized return, and that goes on for 280 months, you might want to be a cash flow buyer.

But, if you're not, if you do want to sell them, then you have that opportunity, and I think that about the lowest that you would go with a performer after one year is 15 percent yield. So, I hope that answers your question Manny, there is a very significant market for performing seconds, I'm not sure where else you can get a 15 percent yield that's secured by real estate that has ... What's very very commonplace in the market today, is emotional equity, where the homeowner wants to stay in the home, and in this case, has $4,000 worth of skin in the game, and made twelve payments or six payments, or whatever. Every time they write that check, they're telling you, "I wanna stay in the house."

That is Manny's question, Manny, I appreciate you asking it, I think it was a very good question, and I hope we've provided some insight there. The second question had to do with IRS tax leans. When you are doing your due diligence on a note, it would be prudent to find out if there is a tax lean from the IRS. Not from it causing a problem with the note, but more importantly, that you may end up with a less than desirous homeowner, and you may want to reflect that in your due diligence. You may want to reflect their lack of paying their taxes, it might influence your decision on what you're gonna pay for the note.

Typically the IRS lean, and I'm not an accountant or an attorney, but I'm gonna just talk to you from experience, you should get some insight from your own professionals. But, an IRS lean is not that difficult to remove from the property. So what happens when someone doesn't pay their taxes, is that the IRS will attach a lean to their property. Which means that if they sell their property, then that lean has to be paid off to the IRS in the priority of the lean.

Now, most often, the IRS will remove the lean from the property, but the debt still remains with the homeowner. But if you buy a note that the home has a lean, typically a lean from the IRS, then through negotiations with the IRS, you can usually get that lean removed. That will not happen with property tax however. And it may not happen if you have a tax situation where it's state income tax or something that like. But with the IRS it's usually fairly easy to remove that lean from the property. You may want to reflect that lean in your offer price because you're gonna have to work harder, you've gotta now negotiate with the IRS, it's gonna take you longer to get a workout. So keep that in mind, but I think you're usually pretty safe by getting it negotiated.

So, again, I want to thank you guys for participating, thanks for the questions, please send them in, that's why we're here. Let me just mention one more time that we are having a bootcamp in Orlando, Florida on May 15th through 17th, and the amount that you invest to come to this bootcamp can be used to buy a note from us, so the bootcamp can be free. It is intensive, we're gonna cover everything from soup to nuts. I think if you went to bootcamps that offered just a slice of what we do, you'll be paying somewhere in the $5,000 range for each of those bootcamps. So please, go to notemogul.com and you'll be able to get signed up for the bootcamp, we look forward to seeing you there, and please send in whatever questions you may have.

Thank you again, see you next week.

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