January 19, 2009
De Borrowers Default
The first time Lawrence Kern called me was about six weeks ago. I was just one of a list of note buyers he was working through, trying to sell a note with a lot of hair on it. He was in a bind, no doubt about it. His borrower had let the homeownerís insurance lapse, and Lawrence didnít have the money to fore-place a policy to protect his interest. To compound an already tenuous situation, Mr. Kernís daughter was about to lose her home to foreclosure, and he felt like he needed to cash out his note to prevent that from happening.
In a nutshell, we had a ten-year interest-only note for $125,000 written at 11.99% on a single-family house in southeastern Florida. At the time the note was written (Sept. 2007), the property appraised at $225,000. Mr. Kern lent the $125,000 via a hard-money loan to the borrower so he could pay off his motherís loan (from whom he inherited the property) and have enough cash left over to replace the roof, install some new flooring, and put in a new pool liner. Mr. Kern held back some of the proceeds in a reserve account to distribute to the borrower as the work was done.
Six months into the note, the borrower called Mr. Kern and asked that all monies in the reserve account be applied toward his future payments. The borrower was a contractor, and work was infrequent and inconsistent. When Mr. Kern called me, there was enough left in the reserve account for one more payment. After that, he expected the note to go into default. At 82 years old, Mr. Kern said he had neither the disposition nor the heart to foreclose and evict his borrowers. Therefore, he would rather take a loss selling the note than suffer through the foreclosure process.
After getting the full scoop (and I must say he was very honest and upfront about his noteís deficiencies), I started thinking about which of my investors might actually have an interest in this note. Technically it was current, but the expectation was that default was imminent. I did have two buyers for this kind of product, so I jotted their names down in the margin of my seller interview form to contact once I hung up with Lawrence.
I called Mr. Kern back the next day after I had gotten pricing back from my two bidders. It was low, but I had already set his expectations that it would be. I reiterated the potential pitfalls for an investor buying a known problem - he understood and agreed to proceed.
The property value was ordered and received within two days. Although Mr. Kern expected the value to still be over $200,000, I tried to be conservative and estimated $185,000 for initial pricing purposes. We were both wrong: The value came back at $140,000. Of course, the price was cut even further to offset the higher exposure to my investor. Reluctant, but ever gracious I was still able to help him, Mr. Kern accepted the re-price.
Now that the hard part was over, we moved quickly to underwrite the file and satisfy any due diligence requirements. As time progressed, I could sense quiet desperation in Mr. Kernís voice. Clearly we were running out of time to save his daughterís home.
The deal funded last week. Mr. Kern wasnít comfortable sending his documents to the investor without cash in hand, so a title company facilitated the closing. I didnít have the heart to ask him to pay the closing fee, so I agreed to cover it for him.
After the funding, Lawrence called me up to express his sincerest gratitude with the way I handled the transaction. He said he and his wife had talked about it over the breakfast table that morning, and felt it was the least they could do to give me a call and thank me. They were able to halt the foreclosure on his daughterís home, and be rid of a note that was quickly going to turn problematic. I could hear the relief in his voice.
Solving problems: Thatís what we do. I happen to know Mr. Kern has several other notes. He told me there would only be one person he would call if he ever needed to sell again. And that, in a nutshell, is really what I wanted to hear.
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