A note holder contacted me with what to most people would be an unsolvable dilemma--an "insecure" note behind a defaulted first loan. The note holder had a $75,000 second note behind a first of about $140,000, including eighteen months back payments and attorney's fees.

The second was created in a do-it-yourself transaction between the parties. The note was created properly, and they thought they created a trust deed to secure it, but no one recorded it. They recorded the note.

I could only find one investor interested in the note. A very bright and creative real estate attorney. We lined up the funding and contacted the owner to help him save the property and reinstate the first loan, which had an attractive interest rate.

Suits and slander

The property owner (payor) was suing the first mortgage lender and anyone else that came within eyesight. My offer to help out and reinstate the first loan was rejected up until the day of the foreclosure:

"Don't you dare give them a penny. I don't owe them anything. They can't foreclose. I'm filing a federal law suit."

Well, the attorney for the bank didn't agree and foreclosed.

Three options--different risks

We were left with three options. One was to advance the funds to reinstate the first and then begin foreclosure on the second.

The second option was to buy the property at the sale. The attorney told us his bid price, and we didn't feel many people would be there.

The third option was to negotiate a deal with the bank after the foreclosure and buy it from them.

Risks and rewards

The risk of the first option is the very high potential of a truckload of legal headaches fighting for the title via foreclosure of this litigious payor. Didn't sound like fun. The risk of the second option is the same as with the first.

The risk of the third option was to lose the property to someone else. Given the condition of the property and the legal problems, that risk seemed remote.

Job security in the REO department

We waited to let the bank foreclose and straighten out the problems. About five months later, I wrote them an offer. It took one month even to get a flat rejection from them. I've never seen such incredibly poor response from a bank REO department. Their job is to liquidate the properties, but few would put up with the attitude of this lender. Tenacity pays well.

A dose of reality

I guess they couldn't understand how a 6,500 square foot property in a prime area could be worth so little. I let them face reality for a couple months and then hit them with a higher offer. I knew their costs from the foreclosure attorney and structured the deal, so they would see little loss: $134,560. They accepted.

At about the same time as my second offer, it probably helped that the rats and chest-high weeds caused one of the neighbors to threaten the city, who then threatened the lender. I didn't orchestrate that, but it sure worked well.

An appraiser had valued the property at $154,000. He was appalled by the condition of the property and suggested to the lender that they would probably be better off to knock it down and sell two lots.

Lenders running scared

The appraisal and the fact that the property was in the process of being "remodeled" scared conventional lenders away. To get the REO department's attention, we had put down a massive amount of earnest money, so to be caught without financing wasn't too attractive.

My options ended up being a construction loan or private money. Neither sounded fun, so I called in the appraiser and had him detail what it would take to upgrade the property to the point where he would not call it a "remodel."

Raising the risk

It was even a struggle to get the bank (seller) to agree to let us pour money into their property before we closed on it. So $15,000 later, we closed on one of the most difficult and challenging first mortgage loans I'd ever done. ($114,000).

No rats this time

The appraiser came back and was stunned. His entirely new appraisal came back at $260,000. It's amazing that the new lender had such a hard time with that new appraisal. They just couldn't understand or believe that someone could make such a good deal--a purchase price of just over 50% of appraisal.

We were able to take the same loan package, and within a few weeks, we closed on a $75,000 home equity line of credit in a second position. So, how does it all end up?

Much more work has been done since the appraiser came through, and a fence line boundary agreement has been put in place to solve lot line problems. The value may be over $300,000 at this point.

"Nasty notes" can be really nice As you can see, there can be incredible profits in buying, fixing, or improving "bad" paper. One of the most profitable strategies in the note business is dealing with "troubled trust deeds."

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