Are you one of those investors who just loves to buy notes? And specifically, non-performing notes? If so, new HUD rules may help you do more of that.
The Department of Housing and Development has announced plans to sell more of it’s pool of non-performing loans to non-profits and local governments, instead of private equity firms.
Why? Because HUD is responding to criticism that private equity investors who buy these delinquent loans from the FHA are not doing enough to prevent foreclosures.
U.S. regulators are concerned that private investors and hedge funds are buying up non-performing loans and then rushing homeowners into foreclosure. There have been cries of foul play from progressive groups who say that investors buy them with the intention of quickly reselling them or adding them to their rental pools.
The program to sell NPLs to private equity investors began in 2012 and is called the “Distressed Asset Stabilization Program” or DASP. The goal of the program is to help reduce debt from delinquent loans and to help homeowners avoid foreclosures. Selling to investors helps attain that goal because they have more options when it comes to loan modifications and short sales.
HUD operates under stringent rules. For example, it cannot reduce the principal on a loan during a modification and it cannot offer interest rates that are below market. It is also limited in what it can pay borrowers to relocate in a short sale.
Investors, on the other hand, have more options to help borrowers keep their homes. They can reduce the loan principal, they can offer below-market interest rates, and they can pay borrowers more to relocate.
There’s concern about whether that’s happening to the extent that it should. And within the last few weeks, HUD announced changes in the sale of non-performing loans that include the tripling of NPL sales to non-profits and local governments.
It would also give them first crack at delinquent loans, ahead of private investors. They will be able to choose up to five percent of the loans in a pool. As long as they meet the reserve price, they will get the loans without competition from investors.
HUD hopes that non-profits and local governments will buy up to 10% of future NPLs that are put up for sale. That’s about triple the number they are buying now.
HUD is also issuing new restrictions on loan modifications. The new rules make “principal forgiveness” a first option, before other methods are considered for modifying a loan.
HUD is also requiring “payment shock” protection by limiting any interest rate increases to no more than one percent per year after a five-year fixed-rate period.
And if a home is foreclosed, loan buyers are prohibited from abandoning the property. That will help prevent neighborhood blight.
Another big change is geared toward “transparency”. HUD says it will release detailed performance data on the NPL sales. That will give outside researchers a chance to study the program and offer feedback on improvements.
HUD previously increased the foreclosure moratorium from six months to one year, to allow more time to find a resolution.
While the Urban Institute appears to support many of the new HUD rules, it disagrees with critics opposed to private investor participation. Instead, it says the situation calls for a balancing act because private investors have the capital needed for such a large-scale effort.
In a report published by the Urban Institute at the beginning of the year, the sale of HUD’s non-performing loans to private investors is a “win-win-win” for borrowers, investors and HUD.
It responded to criticism about investors pushing borrowers into foreclosure as simply untrue. It says the same goes for the idea that HUD is facilitating a massive “wealth transfer” that impacts homeowners and taxpayers. The Institute says that its data shows that borrower outcomes are “significantly” better with the loan sales program, and that HUD gets an average $24,000 more on each loan than it would if they hadn’t been sold.
There’s also been a call for more non-profit participation. The Urban Institute does support stronger partnerships between investors and non-profits, but it also has doubts about the financial ability of non-profits. It says non-profits may not have the funds to service a large loan portfolio unless they work in partnership with for-profit investors.
They also wouldn’t have the experience needed to take on these non-performing assets, might I add! Turning non-preforming notes into performing notes is a skill, and real estate investing experience is necessary. It can be a very difficult task to get a delinquent borrower to pay on time, even if the loan has been modified. And it can be ever more difficult to foreclose in certain states. And sometimes the property is in terrible condition once the investor takes ownership.
Why then, would investors want these non-performing loans in the first place? Urban Institute says the incentive is to maximize profits, of course. Foreclosures produce the “lowest return on investment” and are therefore, often the last resort. The Institute says investors are much more interested in offering borrowers a modification, a short sale, or a deed-in-lieu – which is when a borrower avoids foreclosure by handing over the deed in return for cash if the borrower moves out without causing damage.
The Urban Institute says one of the biggest factors in determining the return on investment is the time it takes for a resolution. Foreclosures take a long time – on average 25.4 months or longer in judicial states. In non-judicial states, it’s more like 18.7 months. Longer timelines mean higher holding costs for property taxes, HOA fees, maintenance fees, and security. They say investors can make more money by modifying loans or with short sales.
Why does our government think it’s so important that investors avoid foreclosure?
Remember we are talking about deeply delinquent loans. They are on average 29 months delinquent when they are handed over to HUD. These borrowers have not been making payments, or covering taxes, or HOA fees for years. Why is it the government’s job to protect these delinquent borrowers? Alas, I digress…
The Urban Institute reports that 25% of these loans sold through DASP have been resolved with a foreclosure alternative. Another 50% are still pending and the Institute believes that many of those will conclude with a foreclosure alternative.
What is the upside for investors? It depends at which point the investor buys the note.
The Urban Institute cites the New York Times as saying that HUD sells the loans to large fund investors at a 30% discount.
Many individual investors would love to buy these non-performing notes at such a steep discount, but they can’t. Typically, you have to buy bulk packages- which only larger equity funds could afford to do. Individuals could then buy one-off notes from these larger equity funds – but not necessarily at a discount. In fact, some of these notes have been offered with hardly a discount at all to the individual investor. Please note: that is NOT a deal.
The FHA is expected to begin selling NPLs under the new rules, this fall. If you’re a note buyer looking for a deal, maybe you should cozy up with a non-profit or become a non-profit so you can purchase NPL’s at the steep discounts offered to large hedge funds thus far.
There are a lot of bootcamps and gurus who teach note investing. It’s important to understand that NPL s are not the easiest investment and are certainly not passive.
If you would like a referral to a great team who can teach you the ins and outs of NPL’s, join the network. We’d be happy to introduce you to the right people.