If you are interested in mortgage note buying, then understanding your buying criteria is critical. Without knowing what you are looking for and how much you are willing to spend, you can make major mistakes when it comes time to purchase a note.
Buying criteria cab vary based upon each person and each situation. It is important to take some time and think about what you desire in a note.
The Comfort Zone
Determine what is in your comfort zone and what are you most familiar with. Your exit strategy will depend on what want to do with the note.
You can keep it for long-term cash flow in a retirement account or flip it to another investor for quick cash. Or even rehab a non-performing note.
Keep in mind…no note will be perfect-all will have quirks you will have to deal with. We suggest you pull out a pen and paper. Write a list of your must haves and deal breakers when it comes to notes.
To get you started, here are a few things to think about when searching for the right type of note for you.
Your Note Buying Criteria
Location
What cities, states, or jurisdictions do you want to your collateral to be located? Do you want to live near or far from the property? If the property is not near you, are you able to have a local person on the ground to send you pictures of the collateral?
Also, examine the rental market for your chosen region. What are the current rents for that area? Is this an up-and-coming growing location? Or is it an established steady market? Choosing the right location can make or break your deal.
Judicial or Non-Judicial
There are judicial and non-judicial foreclosure states. In judicial states, the foreclosure must go through a legal hearing to proceed. In non-judicial states, the foreclosure process may have limited or no court involvement.
Usually, with judicial states it takes much longer to foreclose than with non-judicial foreclosure. Certain states are more friendly to note buyers than others. In New York, a judicial foreclosure state, it takes an average of 2 ½ years to foreclose. In West Virigina, a non-judicial foreclosure state, most foreclosures take about 90 days.
Look up which states are judicial, and which are non-judicial prior to purchasing a note.
Position
Understanding note position is also a big factor when selecting a note. A first position note is the primary lien against a property. It takes precedence against all other notes. If the borrower does not pay on the first position loan, the first position lender has priority over subordinate loans.
A second position note is next in line – it is usually a smaller loan like a home equity loan (HELOC) or other loans used for property repairs.
From an investor standpoint, second position and other subordinate notes are riskier than first-yet can produce higher yields.
Unpaid Principal Balance Price (UPB)
Determine the minimum and maximum UPB you are looking for. This depends on how much financing you have available to purchase.
If you only have $50,000 to buy, you would not want to attempt to buy a note with a UPB of $100,000. The deal simply would not work. Think about the amount of funding you have on hand or line up funding partners prior to purchase.
Property Type
Are you interested in residential or commercial notes? If you like residential notes, would you consider unattached single-family homes, condos, or townhomes? Would you consider properties in a homeowner’s association (HOA)? These are all pertinent questions to ask when considering types of collateral.
From a commercial standpoint, you have many options – multifamily apartments, hotels, retail, industrial, etc. Discover your strengths and knowledge when choosing the best property type.
Performing or Under/Non-Performing
Whether you select performing or non-performing notes depends on your goals. A performing note is one in which the borrower is paying as agreed per the promissory note. A non-performing note is one in which the borrower is not making payments or is not paying as agreed.
If you want steady cash flow, go with a performing note. If you have minimal money upfront and want to own the collateral through possible foreclosure, go with a non-performing note.
Crime Statistics
Are you okay with a property in a more marginal area? Or are you looking for very low crime neighborhood?
You can target the types of crimes committed in certain areas – ie: property crime vs violent crimes. Also, check the amount of police presence in your preferred location.
Websites like SpotCrime can help you get a feel for the amount and type of crimes committed in specific cities.
Remember, you may need to foreclosure on this property and keep it as a short or long-term rental. Know what type of neighborhood and crime level you can tolerate.Market Value
Determine the actual market value of the collateral. Check out sites like Trulia, Redfin, or Zillow to see what similar properties in similar conditions have sold in the last 3 months to obtain approximate market value.
Does the property have low equity or high equity? Evaluating this factor will enable you to negotiate the best asking price for the note.
Financing Agreement Type
Are you looking for properties with a contract for deed (CFD)/land contract or a more traditional mortgage/deed of trust? With a CFD, the seller/lender retains title to the property until the loan is fully paid off by the borrower. With a deed of trust (which is similar to a mortgage) a third-party trustee is appointed to hold title until the loan is paid.
CFD borrowers usually were not able to qualify for a traditional mortgage/deed of trust due to credit issues. This entails a slightly higher risk of non-payment for the lender/note holder. Think about what agreement type suits you best.
No matter what your note buying criteria is, try to stick to what you feel comfortable with – especially as a new note investor. As you become a more seasoned note buyer, you can then branch out and choose other types of notes to expand your portfolio.
