Non-performing loans (notes) are ripe for high rates of return and potentially, large profit margins. The economy is improving, be it at a very slow rate, therefore bank regulations are still encouraging lenders to rid themselves from certain non-performing assets. Currently, there are millions, maybe even billions of dollars’ worth of outstanding debt in single and multi-family real estate loans. A few years ago, banks were more inclined to foreclose on non-performing properties, now they are choosing to sell the notes. This is where you come in.

Basically, banks are in the money lending business. Not owning and operating real estate. Selling the notes to private investors rather than going through the process of foreclosing, a bank doesn’t become liable to the property’s condition, or need to be concerned with property management and ownership issues.  When you add in the cost and effort of marketing the property to potential buyers following a foreclosure and include the performing loans already on their books, it’s easy to see why banks are interested in this alternative.

This is great for you as the buyer because it allows you the opportunity to get the loan and the property at a very steep discount and banks are more than happy to get them off their books. After purchasing the note, you have two options – negotiate a new loan with the borrower or foreclose on the property itself.

To many investors this sounds like an ideal situation, a plentiful supply of inventory at rock bottom prices. It would be unfair to say that large profits and high yields can’t be made from investing in non-performing notes. However, as with most investing opportunities, there are still risks involved.

Knowing what to watch for and the steps you’ll be required to take, it will be easier to determine your risk to reward ratio.  Here are a few things to consider before diving in.

Know the Judicial foreclosure laws in your state.

When you purchase a non-performing note, you may be required to foreclose on the current property owners to retain the property, and get a new owner in the home to get the note performing again. States with judicial foreclosure laws are states that require the parties to appear before a judge to execute a foreclosure. In a non-judicial state, the foreclosure process can be much more streamlined, however you are still required to follow all local and state statues properly.

Determine the best plan to execute a loan modification.

You have the option to renegotiate the existing note that may be more affordable for the owner, much like a loan modification banks perform. Yet this process isn’t something to approach lightly. You need to structure a note modification using acceptable borrower income, qualify the owner, draw up the legal paperwork properly, as well as the new note. Troy Fullwood’s company Pinnacle-Investments carries a great deal of experience in this area.

Review a title report.

You are looking for a clean title as to not incur additional costs over the loan. You will want to review an updated title report to research any existing liens that would need to be paid off before you take over the property. Liens that take precedence over first and second mortgages are delinquent property taxes, federal income tax liens and child support payments among others.

Property renovations can be time (and resource) consuming.

Depending on the condition of the property attached to the note you are buying, you may need to perform some renovations on the property in order to resell it. When you purchase non-performing notes you are typically dealing with a homeowner who has been delinquent on their mortgage for quite some time. This occasionally means the property has been neglected as well. Do a drive by if possible. A lot of times, the outside can be a good indicator of what you might be dealing with on the inside.

At the end of the day.

If you choose to invest in non-performing notes you may be choosing to take on a large degree of risk and a tangled web of unknowns. When you purchase a non- performing note, you are essentially purchasing the situation that comes along with the note.  However, if you approach each NPL carefully and do your homework, the rewards will by far outweigh the risks.