Should a first-timer buy a performing note before touching a defaulted one?

A performing note teaches you one thing worth the money, which is how to read a collateral file properly. Note, allonge chain, recorded assignments, the mortgage or deed of trust matching the note, and whether anything got recorded out of order. You can learn that on a loan where nobody is on a clock and nobody's attorney is looking for your mistake.

Everything else about performing paper is watching money arrive. So it's a partial education at full price.

Price the education. A small performing note at, say, $32k for a $40k balance yielding 11 percent gets you maybe $3,500 a year and no scars. A small defaulted note at $18k gets you a real workout, and if you get it wrong the downside is bounded by what you paid plus advances, which on a small rural file might be $6k of taxes and legal before you quit.

So the defaulted file costs less to be wrong about in absolute dollars. What it costs is time, and $50k of somebody's time isn't on either spreadsheet.

Buy the smallest defaulted note you can find and spend your money on the attorney rather than on the note. That's where the learning is.

I'd do the performing one first, for a reason nobody's said yet. You need a servicer relationship before you need a workout. Getting a licensed servicer to take one small file from a brand new buyer takes paperwork and patience, and licensing and who can collect on your behalf varies by state. Doing that setup while a borrower is nine months delinquent and a tax sale is coming is a bad time to learn the onboarding process.

Or put $25k into a slice of a small note fund and watch how the operator resolves files. You get the reporting, you can ask questions, and you don't need to know anything on day one.

@sable a private fund interest is a security, and whether you can even be offered one depends on rules that a securities attorney should walk you through before you wire anything. Also the reporting you get in a fund is a summary. You won't see the workout decisions, which is the exact thing @orchard is asking how to learn.

My own answer is neither of the two camps. Underwrite twenty defaulted files you don't buy. Build the sheet, get quotes on the legal timeline from counsel in two or three states, pull the free county records, and write down what you thought would happen. Then buy one. The expensive mistakes in this strategy are made at the bid, not during the workout.

With $50k in the rural low price point end you can buy three or four small defaulted seconds or cheap firsts and expect one of them to teach you something painful. That's the version I'd pick, because one file gives you one story and you can't tell luck from skill on a sample of one.

@hollow doesn't buying three at once with no experience mean making the same mistake three times before you find out it was a mistake?

@vellum yes, that's exactly what happens, and it's what happened to me on the rental side. I bought two similar units in the same year and repeated one bad assumption in both. Sequential is slower and it's how you actually learn.

So I'd say one performing to set up the plumbing, then one defaulted, then decide.

Every unit I own taught me something and I paid for all of it. I don't think you get out of that. The question is whether the tuition on a performing note buys you anything, and @fathom's answer is the honest measure of it, one skill, full price.

Still picking performing first for a first-timer with $50k. Not because it teaches more. Because a first loss on a defaulted file often comes with a property you now have to deal with, and that's a much bigger event than a note that just pays slowly.

I'm on a list-building diet right now and the thing that surprised me is how much you can learn without spending. I've read maybe sixty tapes and I can now tell within a minute which files are being sold because the seller couldn't get the borrower on the phone.

There's a point where reading more tapes is a way of not bidding, and I've hit it. I've decided my next step is a bid, even a losing one, because after all this reading I've never seen how a real PSA and a real closing work.

For someone who wants income and not a second job, both of the first two answers sound like a second job. The fund slice is the only one that resembles income, with @sextant's caveat about who's allowed to buy one.

@pike that's my problem word for word. My compromise was to underwrite ten files and send bids on three at prices I'd genuinely be happy with. Lost all three. Learned more from the losses than from the previous four months, because sellers told me where I was.

What does a first-timer actually pay for a small performing note these days, roughly? I've seen people quote everything from 65 to 90 percent of balance, and I don't understand what moves it that much.

@quill payment history, seasoning, the borrower's equity, property type, the state, and whether it's a first or a second. A twenty four month clean payment history on a first with 40 percent equity prices near the top of that range. A twelve month history on a second with thin equity prices near the bottom, and sometimes worse. It moves that much because you're buying somebody's habit of paying, and habits have different amounts of proof behind them.

@orchard, my vote is underwrite first, buy defaulted second, skip the performing note entirely. But I'm still capital-side and preparing, so I'm voting a theory.