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What is a Reperforming Loan?

Financial institutions originate billions in loans each year, yet foreclosure numbers average less than 1 percent.[1]Within that gap lies a special opportunity for some mortgage loan investors who want to turn nonperforming loans (NPLs), those which have gone at least ninety days without payment, into reperforming loans.

Why Banks Don’t Foreclose

Financial institutions are in the lending business, not the collections business. These companies have a massive number of loans to service, and in my experience, they are not designed to effectively collect on delinquent loans. In most cases, they don’t have employees with the knowledge and abilities needed to handle delinquencies.

Compounding this issue is the negative public perception issues facing banks that foreclose on borrowers, especially during times of recession. Most financial institutions don’t want the bad publicity or legal and political scrutiny that comes with filing foreclosures and potentially evicting borrowers from their homes.

Finally, foreclosure is an expensive, lengthy process that in some states can take years if contested by the borrower. In many cases, especially with second liens, it is preferable for financial institutions to write down these loans as loss against their profits and sell them off at discount on the secondary market to a private fund that is willing and able to spend the time and money to file a foreclosure case and ultimately solve the delinquency problem.

Buying NPLs

Banking regulations typically require financial institutions to identify nonperforming loans on their books after ninety days of nonpayment.[2] Once they write the loan down as a loss, they don’t continue to try to collect on the loan. Instead, they frequently sell off the loans to recoup what money they can and put those funds back into circulation, making new loans and generating new fees.

In my experience as an investor in defaulted loans, by the time these loans are sold after being written down, the homeowner is frequently in a better financial situation and motivated to keep their home. I’m not the only investor with this experience, since there are many private investment funds that specialize in purchasing these NPLs and working with borrowers to modify the loans.

Although I have extensive experience in NPL investment, it is a much riskier investment model reliant on complex litigation in a constantly changing legal landscape with no guarantee of any profitable outcome. For that reason, I strongly discourage NPL investment for beginning investors who cannot handle the risk of a total loss of their invested capital.

The motivation behind filing a foreclosure case for an NPL is NOT to displace the borrower; it is simply to get them to resume paying. A foreclosure action requires the borrower to make a decision and address the debt prior to the foreclosure sale. About 60 percent of the time, these nonperforming loans end up with a borrower requesting and agreeing to a loan modification. Prior to modifying the loan, the lender requires the borrower to submit a detailed financial application.

The lender’s goal in a modification is to create a loan that the borrower will not redefault on, so it’s in the lender’s best interest to modify the loan to terms that the borrower clearly can afford. Because the investor has purchased the loan at a significant discount, they can afford to pass on these savings to the borrower in the form of a favorably modified loan, creating a positive solution for all parties.

Once these loans are modified, they are commonly sold in the secondary market as reperforming loans (RPL). I regularly purchase RPLs, both first and second liens, and have found them, over time, to be strong investments. Here’s why:

● Foreclosure is a very stressful experience for borrowers. It forces them to face the reality that they could lose their home, and once they resolve the foreclosure, they don’t want to experience the stress of a foreclosure again.

● A foreclosure filing is embarrassing, since the publicly recorded foreclosure filing is reflected on websites like Zillow, which all of their neighbors can see.

● The bigger the down payment at loan modification, the larger the statement from the borrower that they want to stay in their home and the lower the likelihood of a redefault.

● Since NPLs are purchased anywhere from 20 to 65 percent of UPB, the sellers can afford to sell them with higher yields and deeper discounts since their business model involves flipping the loans to reinvest their capital.

● Borrowers tend to refinance these loans more frequently, due to the higher interest rates, rolling the balance of the second mortgage into just one loan. When that happens, the ROI skyrockets.

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