Top 10 Reasons Why Investors Fail When Investing in Distressed Notes

– By Sherman Arnowitz

I go to many seminars and trade shows and see a lot of people kicking tires. I ask myself how many of these people do I really think will become “serious” investors? How many of them will see the task of what it takes to be an investor and see it through to the end?

Even after taking my courses, I’d say about 25% of my students never do anything with investing. About 25% go off and start investing on their own. The remaining 50% want to start investing, but don’t feel secure enough to “pull the trigger.” That’s one of the reasons why I started creating joint ventures with my students. We take the plunge together and I walk alongside them holding their hand every step of the way. My goal is to get them comfortable enough to be able to do it on their own.
My point is even after taking a course, the student doesn’t really get the full gist of what it’s like and what you need to do in order to become a well-rounded, qualified investor. They haven’t committed mentally, financially and spiritually.

I sometimes wish that when I want to start something new that the qualified people in that industry do everything they can to dissuade me. Tell me the absolute worst things that could happen. Give me the 100% truth of the pros and cons of what I’m about to get into.

Learning the ins and outs of investing is probably the easiest part. You’re learning the basic fundamentals, the language, the scripts and the dos and don’ts. The real challenge comes when you have to apply your learning and actually do it.

I remember speaking to a student of mine after he completed my course. He asked me, “OK, I’m ready, can you start showing me some loans?” I told him it doesn’t necessarily work that way. Loans are not always going to be available. You need to get on the phone and start making tons of calls to banks, friends, family, associates, etc… and start networking. He was baffled to say the least. “What?” he said, “I thought you were going to supply me with all the loans.” This is just one example of expectations versus reality. You need to commit to building your business slow and organically. It will bear fruit for years to come as long as you do what you’re supposed to.

The following article will discuss what I feel are the top ten reasons, investors fail at investing in distressed mortgages.

1. They think they can find tons of loans to buy

The truth is there are still tons of both 1^st and 2^nd mortgages out there (I’m talking billions!). The challenge is finding them. Banks still have these “distressed” notes on their books. They’re just trying to figure out what to do with them. The challenge for the banks is what’s their liability in selling off these notes to investors versus keeping them and just writing them off.
Banks are afraid if they sell loans to one investor who they’ve done business with before and then that investor sells some loans to another investor and that investor starts illegally harassing a borrower, then the bank has opened themselves up for a lawsuit.

Some banks are trying to come up with ways to protect themselves. One concept they’re working on is to make sure that the investor they sell their loans to is licensed. Additionally, if that investor sells a loan to another investor, then that investor must also be licensed. I’m not quite sure what they mean by being “licensed”, but it’s just an idea at this point.

A number of my students think that once they complete my course that they’ll be inundated with offers to buy loans from sellers all around the U.S. I tell my students that if they want to make this a full-time job, then they need to start looking for ways to buy loans. I even furnish them with scripts for when they make calls to banks or send emails to their friends and family. Remember, ours is a very small industry that’s built around trust and relationships.

Here are some ideas for ways to find loans:

Create and send out emails on a regular basis to friends, family and business associates. Tell them what you’re doing and what you’re looking for. Whenever you have an opportunity throughout the day, tell those around you as to what you’re doing. I was in an elevator and looked down at a woman’s briefcase and saw a Chase Bank tag on it. I asked her what she did for Chase and we got to talking. By the time we reached the lobby, I had her contact information and she promised she’d look into who I should be talking to at Chase. You never know!!
Join social media groups and network with other members. Groups within LinkedIn and Facebook are great places to start. Once you gain some experience, you may even try posting articles to establish yourself as a qualified investor. The more you participate, the more people will start to recognize your name.
Attend various seminars and conventions. Speak to the members of your social media groups to find out what seminars and conventions are worthwhile to attend.
Google “distressed notes” and other keywords and then follow up with phone calls and emails finding out more about the companies you’ve selected.
Join Lane Guide, which lists every bank in the U.S. Prepare a script for yourself and pick up the phone and call, call, call!

At the beginning of your journey, you really should be focusing on finding loans. I always tell my students; there are three balls that you’re constantly juggling. There’s the “Where do I find Loans?” ball, the “Where do I find the money?” ball and finally, the “What should I be learning?” ball.

2. They don’t have enough money

Before you even begin to start to invest, you need to decide; should you buy 1^st or 2^nd mortgages, should they be performing, re-performing or non-performing. Based on your answers, you’ll determine how much you’ll need to start investing.

If you’re going to start investing in 1^st mortgages, expect to pay between $.50 – $.80 on the dollar. If you’re looking for a fairly safe investment and the mortgage note is $100,000, you’ll pay about $80,000 for this note.

If you’re going to buy 1^st mortgages and fund them yourself, you should have enough money to buy at least 1-2 loans, (preferably five) to really make a dent.

Because of the tremendous discounts with seconds, you can expect to pay between $.05 – $.30 on the dollar. This means if you buy a second mortgage with a UPB OF $30,000, on average, you’ll pay $5,000 – $6,000 for that note. As you know, there’s more risk with seconds because you are in the second position. However, with more risk comes more reward.

Regardless of which type of loans you buy, you should decide if you’ll be funding all of the loans, or if you’ll be looking for investors. It’s a bit of a catch-22 because when I first started, I wanted to have investors invest with me. However, when I would pitch them, I heard a lot of “you have no experience”. To which I responded, “How can I get experience if you won’t believe in me?” (As a side note, these investors didn’t regret their decision to invest with me.)

The bottom line is don’t have just enough money to invest in a few loans because if those loans don’t perform that well, you don’t want to give up. You’ll do better on the next pool will be better!

3. They think borrowers will welcome their calls

One of the things I hear a lot of from my students is that they really don’t like speaking with borrowers. The first problem is they’re often hard to find and when you do get to finally speak with them, they don’t give you the time of day and are defensive and not very helpful.

Welcome to the world of collections!

These borrowers may be in bad financial shape and often have put themselves into a terrible situation and feel there’s no way out. Here, they haven’t been paying their second mortgage sometimes for over a year and all of sudden, you come along and bop them on their head reminding them of this other debt. Wouldn’t you feel the same way? You have to show compassion and be consistent with what you’re proposing. Otherwise, borrowers will sense you’re not sincere and will leap you in the pile with the other collectors.

I try to put my “therapist” hat on whenever I speak with a borrower. These are real people with real problems and I empathize with them. I try to treat them with respect and tell them, “I’m not here to hurt you, but to work with you to try to get you to start paying your second mortgage with a number that makes sense to both you and me.” I continue to tell them, “I promise I’ll work hard for you as long as you promise you’ll be honest with me.”

Some investors don’t use this method and begin the foreclosure process right from the start. They believe their method of “shock and awe” works well. I prefer to start off by giving my borrowers the opportunity to work with me. If nothing has happened within a three month period, I can always start the foreclosure process if it makes sense.

The bottom line here is communicating with your borrowers is a must. If you feel you’re not rightfully qualified to do it, consider using an outside vendor to do this task.

4. They think it’s easy to find the borrowers

Skip tracing is an art unto itself. Especially nowadays, debtors are more sophisticated and do a great job of not being found. They don’t use traditional house phones and it’s very difficult to get information on cell phones.

I’d say about 70% of the loans I buy don’t have the correct contact information. At this point, I have to put on my detective hat and start looking for clues. I have a whole course dedicated to showing investors ways to locate borrowers. The gist of the course is to not only look in all the usual places, but also try to think outside of the box. Did you really think you were going to get the borrower’s home, work and mobile phone numbers? That’s one of the reasons why we buy seconds at such a reduced rate.

The process involves arming yourself with the correct programs and websites and knowing when to use them. Importantly, be persistent and don’t give up! As tedious as it is and as frustrating as it gets, it’s all part of the job.

5. They have high expectations of what their returns are going to be

I’ve been investing in distressed seconds for over 17 years and the most common question I’m asked is “what kind of returns should I expect?” It’s such a difficult question because there’s so many variables that you need to analyze.

Here are some of the variables to consider when trying to guesstimate what you returns are going to be:

\Will you be investing in first or second mortgages (or both)?
How much money will you be investing? Remember, if you’re going to buy only current notes with lots of equity, expect to pay a premium.
Is this your money or will you be borrowing the money? If borrowing, at what rate?
Will you be focusing on buying performing, re-performing or non-performing notes?
Is your goal to immediately foreclose on these notes or work them for a while?
How long will you hold onto the notes before you decide to sell them?
What is your overall risk tolerance level?
Who’s going to be making the calls to the borrowers?
Who will do the workouts?
What kind of returns would make you happy?

I could probably add to this list, but I think you get the general idea. A lot of thought needs to go into this before you start buying these notes. I think that’s where a lot of investors get tied up and frustrated. They go to these seminars and listen to people bragging about how well they’ve done and they ultimately “drink the Kool-Aid.” Then, when they go to start buying, things suddenly change. The checks aren’t coming in so quickly and one starts to scratch their heads in wonderment.

I say to my private investors that I’m only as good as the average of my past performance. There are no guarantees and in fact I tell them all of the horror stories and reiterate what the worst case scenarios could be.

If you were to take all of the funds I’ve created with some funds having 20 loans and some as many as 600 and If you were to take the average net yearly return, you’re probably looking somewhere between 20-30%. Some of my funds I did amazing, some I did well and one or two, just so-so.

Again, if you know what you’re getting into and what the up and down sides are, it may help with your expectations.

6. They think they know just enough to be dangerous

When I started out buying distressed second mortgages, I bought 12 loans from Ditech. I was so excited to be on my way. Upon calling the borrowers, I found out that four of the borrowers had already been foreclosed on “before I purchased the loans.” I quickly called Ditech and explained the situation and asked for my money back for those four loans. They told me that if I looked closely at the Purchase & Sale Agreement (PSA) that I’d see the reps and warrants clearly stated that these loans were being sold, “as is.”

I was devastated! I just lost over $15,000 because I didn’t fully comprehend what I was reading.

This is the example that I tell my potential students who ask me about the cost of the course. Back when I was starting out, I only wish there was some sort of education program that I could have taken. If I had only done my proper due diligence, I probably would have saved my $15,000.

The number one thing I tell my students is, “the success or failure of a note begins with the type of note you buy and the price you pay for it.” There are over 10 variables to look at when researching your loans to buy. Additionally, there are three to four “what-if” situations that you need to play out in your head with each of the loans you’re interested in.

If I told you, “give me $5,000 and I’ll save you thousands of dollars.” Would you do it? You can’t minimize the value of a good, sound education.

7. They don’t use vendors when they should

It’s impossible to be all things to all people. However, when you start investing in distressed notes, you need to wear many hats – To name a few:

Negotiator – You’ve got to negotiate with the seller on the loans you want to buy. You very often negotiate with the borrower to come to a mutually beneficial arrangement.
Detective – Not only do you have to search out informa tion during the due diligence stage, but once you buy the note, you sometimes have to find the borrower.
Financial Advisor – You’ve got to be pretty “savvy” when it comes to offering financial advice to your borrowers, showing them ways they can save money and start paying you their monthly mortgage.
Lawyer – Being diplomatic and weighing options takes a lot of practice and discipline. Sometimes you need to be in “lawyer mode” when dealing with sellers, borrowers, trustees and other lawyers.
Poker Player – Sometimes you’ve got to know when to hold ‘em and know when to fold ‘em! Being a good “bluffer” comes in handy when dealing with your borrower and/or seller.
Therapist – If I could count how many hours I’ve listened to borrowers telling me of their financial and personal situations, I’d be an honorary psychologist. Dealing with borrowers who are in these terrible situations takes a lot of diplomacy, sympathy and patience. You have to be a good listener!

Chances are, if you’re like me, you might be really good at one to two of these skills, just adequate at two to three of them and really bad and hate doing three to four of them. That’s the beauty of this industry. You don’t have to be great at all of them. What you do have to be good at is being honest with yourself. Identify what you’re good at and what you like to do out of all these skills. With the remainder, you can find vendors and other people that excel in these skills. In the long run, you’ll be so much better off and much more productive!

8.They get discouraged when some of their loans don’t perform

As I mentioned above when talking about expectations, you can’t expect to hit home runs every time you’re up at bat. Be happy with singles and sometimes, you’re going to strike out.

Every time I start a new fund, I ask myself, “Do I still have it? Will lightning strike again?” I believe if you stay true to your business model of the types of loans you want to buy, the risk you’re willing to take, the money you’re able to invest and acknowledge your expectations, you’ll do ok.

After a while, you’re able to see patterns in not only your individual loans, but in the pools as a whole. Here’s a breakdown of what you’ll start to see as you begin to make your calls:

Some borrowers will answer your phone calls and agree to start paying what their monthly mortgages were.
Some borrowers will agree to pay, but can only pay a percentage of their monthly mortgage.
Some borrowers will refuse to pay no matter how low a number you’d accept.
Some borrowers can’t be found. You need to determine if it’s worth foreclosing.
Some borrowers will be foreclosed on by their first mortgage and there’ll be no surplus funds for you.
Some borrowers will be foreclosed on by their first mortgage and you will receive surplus funds.
Some borrowers will agree to a short sale with you, might be able to refinance their 1^st and 2^nd mortgages or will sell their house. You’ll get all of what’s owed to you or at least a decent portion.

If you’re able to monitor and keep track of these seven variables, you’ll be able to compare from fund to fund how you’re doing. The patterns that I was earlier referring to relate to these categories. Whether you buy 10, 50 or 100 loans, these categories should fall within the same percentages.

9. They don’t look at it as a business

Most investors think of themselves first and foremost as “investors.” I think of myself as a “businessman” who invests in distressed mortgage notes. The difference being that I have to keep my eye on the big picture, which is making money.

For example, I once bought a pool of 30 second mortgages. We did our usual due diligence and bought them for about $.15 on the dollar. After the first quarter, I analyzed the pool and discovered two things that shocked me.

The first was our percentage of borrowers paying us was at an all-time high. We had 52% of the borrowers paying us. I started jumping for joy.

However, the second thing I noticed that even with all those borrowers paying us, it would take five years to break even! I thought, how could this be? When I drilled down I saw that we were negotiating with these borrowers and reducing their monthly mortgages way too much. Some who were supposed to be paying $250 a month were paying us $75 a month claiming they couldn’t afford anything else.

When I was able to look at the entire pool as a whole, I realized that this type of payment structure didn’t fit into our corporate business model. I decided to sell the pool and get out while I could.

This is an example of not just looking at your loans, but looking at them as a whole. Are they coinciding with your business model and expectations?

10. They give up too easily

I can’t tell you how many phone calls I get from frustrated and depleted investors telling me of their woes or asking me if I want to buy their portfolios. When I ask them where they think they went wrong, invariably they convey at least two to three topics covered in this article.

I think more than anything, most investor think investing in distressed mortgages is going to be a slam dunk. They then realize that it’s a lot harder than they thought it would be. I believe part of the reason is the research they do, or don’t do, listening to other “guru’s” telling them just how easy it is to get into this business and make money.

I compare this to what led to the crash of 2008. Banks were lending money to anybody with a pulse, even if they knew these people weren’t qualified. And, on the other side, borrowers were taking out these mortgages when they knew they really couldn’t afford them. Perhaps if the banks were a bit more informative and direct with their potential borrowers and the borrowers did a little more research and soul searching, we wouldn’t have had such a disaster.

For all of you out there who want to start investing in distressed mortgages, I say, do your homework. Speak to as many people as you can. Ask them “What’s the worst thing that could happen and how often does it happen?” Ask those offering to teach you to take you through a typical year in the life of an investor. Ask to see financial reports of the funds that they’ve created and managed.

One of the statements I hear the most from potential students and even students is, “I don’t have time to do all it takes. I’m too busy with other stuff.” I’m sorry but I don’t get it.

Example: If I buy six second mortgages, here’s the amount of time I’m probably going to spend on them:

Month 1:

Research and negotiate to buy six notes

Collect and review all collateral

Prepare and send files to servicer to board

File Assignment of Mortgage with County, enter info on each borrower into Computer

Send Welcome letter, start making calls to borrowers with phone numbers

Start skip tracing to find borrowers without phone numbers

3 hours

2 hours

3 hours

Month 2:

Continue to call borrowers. Out of six notes, two have agreed to start paying

Continue to skip trace to find borrowers without phone numbers

Contact lawyer to send Demand letter out to two of the borrowers

2 hours

Month 3:

One of the loans has been foreclosed on, write it off for accountant

One of the borrowers who received the Demand letter has called and you’ve modified their note.

1 hour

As you can see, as time goes on, you end up spending less and less time managing your notes. During this cycle, you may find more loans to buy and the cycle will start all over again with your time commitment.

Ultimately, it’s the investor’s responsibility to find out as much as they can about becoming an investor. Additionally, asking themselves if they can see themselves performing all those tasks and if they can make a commitment to see it through.

To sum it all up: