Note Buyer Burns to Learn – Real Deal #160

Wonder why note investors require proof of insurance before buying notes? This Oregon cash flow note explains it all!

The Note Basics

• Property: Owner Occupied Bungalow
• Type: Note and Trust Deed
• Sale Price 45,000
• Cash Down 5,000
• Original Balance 40,000
• Rate 10.0%
• Term 180 payments of $429.84
• Payments Made 26
• Current Balance 37,128.94

The Offer

The seller accepted our offer of $31,250 to buy the trust deed. This started the standard review process, including documents, title commitment, and a verifiable payment history. The appraisal reflected good property condition with known value increases putting the fair market value at $60,000. While the buyer had poor credit, everything else looked good for purchase.

We prepared for closing and required standard proof of hazard insurance. The seller returned the document package along with the insurance information. We called to verify coverage, which was verbally confirmed by the agent, and authorized the wire transfer to the seller.

Under Pressure

On the day the wire transfer was authorized at the bank (a Friday) we received a return call from the insurance company stating they were in error. The hazard insurance policy was no longer in place due to nonpayment of the premium. We attempted to contact the buyer but no answer.

Under time restraints, we decided to move forward and did not pull the wire at the bank. We sent the standard notification letter to the buyer along with a request to clarify the insurance issue. We planned to force place insurance if sufficient proof was not provided.

Things seemed in order until the adjoining property owner called the office the following week. They wanted to make a $10,000 “as-is” offer to purchase the “lot” next to their $250,000 home.

Guess what?

The house covered by the note had burned down over the weekend. We were left with nothing more than a lot, a burned out shell, and some charred debris as security.

Could it be true? First a call to the fire department to verify the date of the fire and the condition of the property. Next we ordered a property inspection, contacted the appraiser to obtain a land only value ($24,000 – $29,000), and traced the buyer whose home phone was no longer in operation.

A Sad Situation

Once we made contact with the buyer we confirmed our fears finding he did not have insurance. He explained how the insurance premium money had been used to purchase prescriptions for his recently deceased wife who did not have health insurance coverage during her fight with cancer. He was a self-employed car mechanic and his income was currently down.

It was a sad situation without a good solution. Initially the buyer seemed cooperative and wanted to continue payments until he could sort out his financial affairs. He was interested in placing a mobile home on the lot and hoped we would help finance it. We were happy to explore the possibility and asked for a show of good faith in the form of current payments during the interim.

Unfortunately the buyer’s financial situation declined, payments were never received and we ended up holding a Deed in Lieu of Foreclosure. We attempted to sell the lot but realized most new building activity was being done on small tracts of land outside the city limits.

Just Being Neighborly

The neighbor was a local businessman who owned a nicer home in this small bedroom community of mixed homes. He was NOT happy with the condition of the neighboring lot and increased his initial $10,000 offer to $15,000. We explained the land only was appraised for $24,000 – $29,000 and we weren’t ready to take such a loss. We also offered a seller carry back if we came to an agreeable price.

He didn’t need owner financing. His concern was the view.

Understanding his motivation, we explained we were considering the placement of a used singlewide mobile home on the lot (1969 or newer according to zoning requirements), which we would offer to a new buyer with owner financing if we were unable to sell the property as a lot. We waited (or I should say sweated) the situation out and the neighbor offered a cash purchase price of $23,000 provided the lot was cleaned.

Now the Burn to Learn

Initial estimates for clearing the lot had come in between $5,000 to $7,000. We contacted the fire department regarding their “Burn to Learn” program. The fire department agreed to arrange a practice drill on the property resulting in a complete burn of the remaining structure and approximately 95% of the debris. The remaining debris could be hauled away at a nominal expense.

We accepted the neighbor’s offer resulting in a loss after expenses of approximately $10,000. The transaction closed and I was never so relieved to have lost “only” $10,000.

Lessons Learned

So, what did we learn moving from note brokering to note buying?

1. Don’t be rushed or pressured into making investment decisions

2. Perform a verbal debt verification or payer estoppel with the purchaser even if the account is serviced through a third party servicer.

3. Require current insurance at closing even if the seller has to pay and obtain insurance on the buyer’s behalf from the note proceeds.

4.  Creative thinking is required to buy and hold private mortgage notes.

Is this Déjà Vu?

A few months later we were ready to fund on a seller financed note in Alabama with a current insurance declaration page in the file. After calling the agent we found the buyers had not kept their premium current and coverage had lapsed.

Had we truly learned our lesson? That’s a resounding, “YES!” The closing was put on hold for proof of current insurance prior to funding.

We called to follow-up several days later only to be told the house had burned down the night before! It was another sad story but a good reminder of why mortgage note buyers confirm insurance coverage at closing and during the life of the account.

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