Your income stops and your claim stays. You still own a debt secured by a lien on the property, and your options run from a phone call to foreclosure. Each one costs time or money, and how it ends depends above all on how much equity sits behind your lien.
Find out what has happened
A late payment and a default are different things. Default means the borrower has broken the terms of the note in a way that lets you act. Read the note for the due date, the grace period, the late charge and the notice you must give, since those terms decide what counts as default on a note.
Then find out why the payment was missed. If a servicer collects for you, it makes the first contact. A payment that bounced because the borrower changed banks is a different problem from one that stopped because of a lost job, a death or an abandoned property.
Your options, mildest first
- Reinstatement. The borrower pays the missed payments and late charges and the loan carries on as written.
- Repayment plan. The arrears are spread over several months on top of the regular payment.
- Forbearance. You agree to accept reduced or no payments for a set period. The amounts are still owed.
- Modification. You and the borrower change the terms in writing: the rate, the length or the payment.
- Deed in lieu. The borrower hands you the property voluntarily and you release the debt. See deed in lieu of foreclosure.
- Foreclosure. You use the legal process to have the property sold to pay the debt. See whether you can foreclose as the owner of a note.
- Selling the note. You sell the non-performing note to a buyer who works defaults, at a price that reflects the trouble.
The first five need the borrower’s agreement, while foreclosure and a sale of the note can go ahead without it. What each route costs and how long it ties up your money is the subject of exit strategies for non-performing notes. Consumer protection rules can govern how and when you contact a borrower and what you must offer before foreclosing, especially on an owner-occupied home. They differ by state, so work through a servicer and an attorney who know them.
What it costs while you decide
The first cost is the obvious one: the income you bought the note for is not arriving. The second can be cash out of your own pocket. If the borrower has also stopped paying property taxes or insurance, you may have to pay them yourself to protect your lien, since unpaid property taxes generally rank ahead of a mortgage. Those payments are called protective advances.
Default work by the servicer and the attorney is billed on top of ordinary servicing. Then there is time, which in a foreclosure depends on the state, the court and whether the borrower contests it. Some of these costs can be added to what the borrower owes if the loan documents allow it, though being owed more only helps when the property is worth enough to cover it.
What decides how it ends
The outcome was largely set on the day you bought. Equity, the gap between the property’s value and everything owed against it, gives a borrower a reason to catch up or sell, and it is your cushion if they do neither. Lien position sets the order of payment: a first lien is paid first from a sale, and a second lien is paid only after the first is satisfied and can be wiped out by the first lien’s foreclosure. Your paperwork has to prove the loan is yours, and a default is when gaps in the chain of ownership come to light.
The price you paid matters as well. An example with round figures: if the borrower owes $100,000 and you paid $85,000, you have $15,000 less at risk than the balance, 15% of it. That margin is room to agree a workout that still makes sense for you.
Equity, lien position, paperwork and price can all be checked before you bid, using the due diligence steps in the investor guide. If you join the buyer list, check them from the documents on every note we send, whatever our summary says.
If the borrower files for bankruptcy
A bankruptcy filing generally pauses collection and foreclosure while the court deals with the case. A secured lender stands in a stronger position than an unsecured one, but what happens next depends on the type of filing. Stop contacting the borrower and call a bankruptcy attorney.
Decide your answer before you fund
Any note can stop paying, including one with a clean history. Before you buy, write down what you would do if the payments stopped in month three, and check that you have the cash to carry the note through the route you chose. Put a figure on it: the months of missed income, the taxes and insurance you might have to advance, and the attorney’s bill.
Related questions
Do I have to foreclose as soon as a payment is missed?
No. Foreclosure is one option among several, and it carries legal costs that reinstatement, a repayment plan or a modification do not. The note and state law also set notice steps that must come first.
Can I lose money on a note that is secured by property?
Yes. If the property is worth less than what is owed ahead of you plus your costs, a sale may not cover what you paid. Unpaid property taxes, a senior lien, legal fees and a property in poor condition all reduce what comes back to you.
Should I contact the borrower myself?
There are good reasons to leave it to a servicer. Rules on how and when a lender may contact a borrower vary by state and can be strict on owner-occupied homes. A servicer also keeps a record of every contact, which you may need later.