In this episode, Chris breaks down one of the most misunderstood aspects of mortgage note investing—how to price non-performing loans correctly. Drawing from real case studies, he explains why assuming a fast foreclosure timeline can lead to major miscalculations, how borrower behavior (like filing for bankruptcy) impacts your timeline and return, and why the biggest risks often come from what you can’t predict.

Chris also shares how 7e models downside risk using IRR and scenario planning, why adding just one month to your assumptions can save your entire deal, and what to do when legal errors, borrower beliefs, or delays threaten your outcome. This episode is a must-listen for investors who want to move beyond surface-level deal sourcing and understand what it really takes to manage notes profitably.

This is part one of a multi-part series on loan pricing fundamentals.

Welcome back everybody to another episode of the Paper Trail podcast.

I'm your host Chris 70 of 7e Investments and if you are looking for mortgage note investing information and how to buy non performing loans, do seller financing, get involved in private lending, then you are at the right place. We here at the Paper Trail want you to follow that paper trail and dive into the details, the specifics on how to invest in this asset class.

We are not your typical let's show you how to market and only find deals. We want to show you how to make money on deals.

Today I am going to be talking about pricing non performing loans and how to value them for maximum returns.

And this is going to be a multi part segment that I'm going to be talking on this topic because there is a lot of information that I want to provide to investors. So sit back, enjoy, I got my cup of coffee, cream, no sugar, the way I prefer and we are going to dive right in.

So for those who have not listened to me before, definitely go back and listen where we talk about the three P's analyzing the person, the predicament and the property. But as you get experience and go through the due diligence, you will see things that start to be more commonplace and patterns will prevail.

And like any type of investing or playing sports, which is, you know, something I've done, you know, a lot throughout my life, you always, I'll use the term, are playing the odds. And what do I mean by that?

What I mean by that is looking at a situation, what are some of the more common likely scenarios and make sure you evaluate them to see how they impact what you're doing, in this case your investment.

You might not be able to always base your pricing entirely on a specific predicament because you may never win a bid, but you definitely want to understand what could happen in the risk. So we're going to talk today about some of those mistakes.

And the other reason I wanted to talk about this topic is I see a ton of information out there now talking about how to calculate returns. Do you use irr, xirr, roi, cash on cash, all of these things.

And I'll tell you, yes, we use internal rate of return for our investments and we use it to a calculate what we anticipate on a return, but also to evaluate scenarios. For example, if somebody's going to give you $5,000 today or $10,000 in 16 months, which is better? Good question.

Way we would figure that out is by irr, but not going to dive that deep into the Weeds on this session because you're probably sitting in a car driving around or you know, listening to this on a walk or however you are listening.

We are going to just give you some of the mistakes, how to avoid them and how to make sure you're at least taking them into consideration if they are unavoidable. So mistake number one we're going to talk about is assuming a fast foreclosure in a non judicial state. What does that mean?

So let's rewind a little bit. If you're new to note investing. There is judicial and non judicial states.

A judicial state is where you go through a foreclosure process through the courts. You have to file a lawsuit which is called a complaint, and then get summary judgment that allows then the courts to file a sale with the sheriff.

And judicial states can take a year, five years. Really depends on the state. We are seeing judicial states, those timelines really starting to expand.

And I think they will continue to expand because even though we're at all time lows for foreclosures, the media will make it sound as if there's an uptick in trying to keep people in their homes as fast as possible. Non judicial states are.

There's a third party that is typically a law firm that is the trustee that goes through the foreclosure process, that files basically sends some documents and then notifies it in the newspaper. And this process can be done in, you know, three, four, five months. So much quicker process.

And I'll actually share some case studies today in regards to real life situations and scenarios where this of course plays out. And I'll give you an example. A borrower is two years behind on their mortgage. Prior lender didn't do anything, just let them not pay.

Property is worth $500,000 and they owe 200,000.

What I see a lot of people with less experience do is go in, buy that loan, assume that they're going to foreclose in three to four months and make a quick buck on that deal. Now if you lived in a house that's worth 500,000 and you couldn't make your payments, you really have three options.

You can sell the house on the open market and get the maximum value for it.

You can let it go to foreclosure and most likely would get about 70 cents on a dollar, maybe less, or file bankruptcy, which allows you to restructure your payments, keep your equity and potentially keep your house or it at least buys you another year. What do you think borrowers in these situations typically tend to do. Typically they file bankruptcy.

That could turn a quick foreclosure into significant delays. What also this may potentially do is increase carrying costs.

It will increase your legal costs because in bankruptcy you have to file proof of claim, which is roughly $1,000 and go through that process. Let's say even the borrower doesn't make any payments in bankruptcy. I have two cases right now where this is occurring.

One in Texas where borrower is behind, they believe there's equity in the property. And again it's not also whether there is or is an equity, it's what does the borrower believe?

Because in this instance there is no equity in the property. Actually in both instances, I'm going to talk about one in Virginia, one in Texas, the borrower believes there's equity and there is not.

Instead of letting it go to foreclosure. In both instances, they file bankruptcy.

They file bankruptcy and as part of the bankruptcy they have to fill out all this paperwork, which we actually like bankruptcy because it's an open book where they have to provide all this information. But it takes time. And then the courts will schedule a hearing.

Then the bar has to continue to submit its information and the borrower during this time is supposed to be paying, but we'll see if they do or don't. And then they have a hearing to get the bankruptcy approved. Once the bankruptcy is approved, then the courts can start issuing the payments.

But you can't foreclose. There is a stay meaning they can't foreclose. And it's as if the loan is brought current.

So even if the borrower stops paying in bankruptcy, you typically still have to wait 90 to 120 days that they're behind again. And then you file a motion for relief and get a motion for relief which is take, pulls it out of bankruptcy. But that could take another 60 days.

Long story short, if a borrower files bankruptcy, assume it's going to take a year. Now how do you predict all of this? You can't. You can again use some common sense to understand what they may or may not do.

And let me give you some ideas what we do. We look at what will happen in the possibility of bankruptcy and evaluate what those returns will look like.

If the borrower is really behind and they started making payments, maybe it's not a bad. It's still maybe not a bad deal.

If the borrower is six months behind at a low interest rate and they file bankruptcy, that can really impact your returns. So here are some of the things we also do within our calculator or when we analyze these is in Texas. If I look at timelines it might say 90 days.

Well we typically will add a month to that time frame. Why do we add a month? Because think about driving on a highway. I've lived in Boston and D.C. two of the worst traffic places in the planet.

You know you can get, I can get to DCA airport in no truck.

I can actually be leave my house, get to the airport and be through the gate in under 20 minutes at 4:00am in the morning because I'm about eight miles away now. If I did that at 9:00 clock in the morning, how long do you think it would take me? An hour would take you longer.

There's delays, there's things that outside forces that you don't control that can impact your foreclosure. What are some of those forces?

Your attorney filing, the proper documentation, your servicer getting you the information so you can get it to the attorney and then things can happen. We've had an attorney on two occasions in non judicial screw up the publishing twice. We were supposed to have a foreclosure this past July.

We had to cancel it in July because they screwed up. It pushed it three or four weeks. Then I think beginning of August they screwed it up again. What can you do?

Can yell at them, you can scream at them but doesn't make you feel any better. It's not like can go back to them say hey now my IRR is hurt because I'm carrying this loan longer and they're going to reimburse you for it.

That stuff happens. So we will typically add an extra month to the process, some on longer foreclosures.

If it's a 15 month in timelines we might add two months but we do not anticipate the shortest duration or the perfect path. The reality is if it happens then great, you do better. If it doesn't, you got some downside risk and it's weighing in how much you can factor in.

Factor in a year, forget it because you're never going to win a bid because your number is going to become too low.

So it's that balance of that gray area which nobody ever wants to talk about, you know in note investing everyone wants to tell you how to market, how to go on LinkedIn and find leads or call banks and all this BS which you know that's not the part of node investing. Anybody can do that. It's the gray area of pricing loans, managing loans.

You know if this then that, that nobody talks about except us, I believe, because we experience this every day. We're actually in the business of doing this. Okay, sorry for that little rant.

So this gray area of fine tuning, now there's another avenue that we also look at when we're going down this path. What if you take a property back that fast, foreclosure that you thought, oh, I'm going to foreclose and it's going to sell at auction?

What if it doesn't? Now you have to continue carry insurance, continue to pay the taxes. You might have to file eviction.

You have to wait for the courts to actually issue the deed, which can take a month so you actually have ownership. Because at foreclosure sale you might win the bid, but you still have to wait for the deed to be transferred to your name.

You have carrying costs which can get pretty extensive. It's another thing we factor into our pricing. We carry three or six months on every foreclosure.

Even if we think it's going to sell at auction, we will analyze it as if it sells at auction. Then we'll analyze it at three and six months of hold time. See how do those numbers factor in?

You know, is it a big difference in the numbers based off of those hold times? Something important to consider. Sometimes we might not carry any. Sometimes we carry six months, sometimes we carry three months.

You know, that will have a significant impact on your numbers. Note investing. You know what the payment is. What you don't know is your costs or your time. So you have to factor in how do those impact your returns?

So this is the avenues that I want people to open their brain and think about of all these situations. Because as I mentioned, carrying costs and legal fees can destroy those returns.

So in this one in Texas, we bought this loan last year and we anticipated it would be a four month foreclosure. And basically we put a six month hold period and we've actually gone by Those past, those 10 months already that we anticipated in there.

We do have a foreclosure date coming up. Finally, because the borrower filed bankruptcy, it got dismissed. So in this instance, you know, we're past our timeline.

Does it mean we're going to make less? It's going to boil down to, honestly, you know, what the property sells for. We're not going to lose money because we bought it at a discount.

But are we going to make what we make? Maybe, maybe not. And then if we do take it back, we then do a whole another analogy of do we do work on it to increase value?

Does that hold time and increase work give us a better return than it doesn't? We did a case study on a property in Nevada that we sold for. We took it back and we could only sell it for between 1 to 1.2 million.

We took it back, but $250,000 roughly into it and it sold for around 1.9 million. That instance, yes, we won. Other instances, it's better to fish, you know, it's better to cut that bait.

Southern asset we have in Virginia, borrowers trying to sell it as well and also started the foreclosure process. Interestingly, the borrower is underwater.

They believe there's equity in the property, which they, I guess I should reframe that they can't add because they mentioned they could sell it for X, but then they mentioned they owe us Y and they owe somebody else Z, and Y plus Z is greater than X. But for some reason they think that they can come out whole on this. So they file bankruptcy to try and protect.

Which unfortunately what happens many of these instances too is again, the clock doesn't stop. So they still owe money, it's still accruing interest and it's still accruing taxes and insurance. So the costs continue to rise.

And in many instances these borrowers don't understand that if I could sell a Property Today For 400,000 or in six months for 420, the 420 probably isn't a better answer because it's probably accrued more than $20,000 in cost during that time. So this is another avenue of just understanding. But also remember, there's common sense, but it doesn't matter what you think the property is worth.

It also depends on what the borrower thinks the property is worth.

So in this asset in Virginia, you know, we bought it, I think in April and we assume that we'd be able to exit this in 10 plus months, which is January, we're recording this now in September, we are actually in the process of filing motion for relief from stay to allow the property to be sold and we'll see if we hit that timeline. Now you may be thinking, Chris, well, you're putting these in and you're not hitting them. You know, is it, does this happen all the time?

No, in some instances we get it sold in four months and we, you know, that six months of carrying costs and everything else ends up winning for us and does better. The other aspect or thing that we also do put in our numbers is if a property is worth it. I'm just going to use easy numbers.

A million dollars or we think it's worth a million. We, you know, in our analysis do not calculate that we would receive the full million. We discount that number 5 to 10%.

We also include costs as if we were to sell that with an agent and we typically carry about another 10%. So $1 million property, we might discount it to about 850,000. Why do we do that?

Because again, it provides some downside risk if the property, you know, doesn't, isn't not worth it. And let's say a property was worth 975. Great. Property was worth 975.

And let's say we're able to sell it with an agent at 4% now there's an extra 50,000. So at 925 we're still winning. And that's another avenue where in that instance we typically do very well on our analysis.

I'd say we do very well on analysis in every situation. But we put in our analysis, you know, these downside risk measures. Again, extended time, extended carrying cost, discounted pricing.

You made 25% and four to six months, which is 50% annualized. That is really good. Let's say it extends, goes past the year and let's say it took a full year. And because you foreclosed and had to take it back.

So not only did you spend 5,000 on foreclosure, you had 5,000 in holding costs. Now you're in it for 85,000. Let's say it even sold at 100,000 after a year. Now you just made 15 grand in a year, which is a 15% return.

Big difference. Still making money.

Now let's say, you know, it had to pay realtor commissions and fees and everything else, then you only make 90 and you're in for 85. See how all of that compresses down, down, down.

Yeah, we learned that from the hard way seven, eight years ago and making sure we follow this process. But if it's for now, if it's a hundred thousand dollar loan in our books, we might value it at 85,000 and carry a year to be in it.

So we're probably bidding maybe $60,000 for that asset and if we get it, great. If we don't, we'll move on. But we understand those costs in giving us the upside and playing, you know, making sure we protect that downside risk.

Far too often I see people with the rosy colored glasses just going through it and picking out the perfect scenario that can occur, like driving down the highway or going somewhere, you know, trying to get to the airport 30 minutes before you board and only giving yourself 30 minutes. You get stuck in traffic and get stuck at security. Too many things can happen along the way.

And in note investing, you want to make sure you account for those Hope you enjoyed this episode of the Paper Trail podcast. As always, leave us a like leave us a review. We have our Facebook group. The Paper Trail can follow us on LinkedIn.

If you're interested in more information about 7e Investments, go to 7e Investments.com. hope you enjoyed this episode. We will continue talking about some of these other quote unquote mistakes that we see.

But until then, I will catch you on the next one. Thank you all.