Contractor here, someone offered me a note on a house I renovated

Question

A private lender I know is selling a note on a house I did the kitchen and bath on a couple of years back. Owner-occupied, borrower has apparently paid every month since. He wants roughly 85 of the balance, balance is around $95,000.

My whole world is scope and materials, so I understand the house fine. What I don't understand is what I'd own. I'm used to owning the thing. If I buy this, do I own the house at all? What happens to me if the roof goes and the borrower can't pay for it? On a rental I'd just eat the roof. Here I'm not the owner, but I'm not exactly a bystander either.

Rena Guide · Accepted Answer

You'd own the debt, not the house. The borrower owns the house and keeps owning it as long as they pay. You hold the note, which is their written promise to pay, and the mortgage or deed of trust, which is the lien letting you force a sale of the property if they stop.

That answers the roof question in a way that feels strange the first time. The roof is the borrower's problem. You don't pay for it, you don't approve it, you don't hear about it. Your exposure is indirect. A borrower facing a $14,000 roof on a house they owe $95,000 on may prioritize the roof over the mortgage payment, or may not fix it at all and let the collateral degrade. Neither gives you a bill. Both can eventually cost you, because if you ever do have to foreclose, the house you take back is the house as it actually is.

The one thing you can and should control is hazard insurance. Your position as lienholder normally entitles you to be named on the policy so you get notice if it lapses, and most servicers monitor that. If the policy does lapse, servicers typically place forced coverage and add the cost to the loan, which is expensive for the borrower and a common reason a paying borrower starts missing.

Since you know this house, you're in an unusual spot. Most note buyers order a broker price opinion, which is a licensed agent's drive-by valuation, usually somewhere around $100 to $200. You already know what's behind the walls, which is worth more than that report. What you don't know is the borrower, and on performing paper the borrower is the asset. Ask the seller for the pay history and how the loan was underwritten when it was made.

devon_pierce · Answer

The renovation knowledge cuts both ways though. You know the house was worth fixing when you fixed it. You don't know what the borrower has done to it since, and owner-occupants two years into a loan sometimes do interesting things to a kitchen.

Rena Expert · Answer

Adding the part that matters more than the collateral in your situation: you know the seller personally. That's the most common way people end up overpaying for paper.

A private lender selling a performing loan at 85 has a reason. Sometimes it's fine, they need liquidity for the next deal or they're winding down. Sometimes the borrower has called about a hardship, or the property taxes went delinquent and the lender doesn't want to deal with it, or the loan has a balloon in eighteen months and the lender doubts the borrower can refinance. A balloon on seasoned private paper is the thing I'd ask about first, since a performing note with a balloon you can't collect is a non-performing note on a schedule.

Ask for the note itself and read the payment terms, the maturity date, and whether there's a prepayment penalty or a default rate. Ask for the servicing history if a servicer was involved, and the deposit records if there wasn't, because a private lender collecting checks directly may have a pay history that exists only in their memory. Then have a real estate attorney in that state review the assignment and confirm the chain from origination is clean, because state recording practice differs and a defect is much cheaper to find now than at a foreclosure.

mikeoconnell7 · Answer

@harrow the balloon question is the one I'd lead with. A lot of private paper written on rehabbed houses is three or five year money that was never meant to run to term.

Contractor here, someone offered me a note on a house I renovated

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