The majority of the loans I’ve acquired have been contract for deeds (CFDs) instead of traditional mortgage notes. I’m not going to do a deep dive on what CFDs are and how they work, but I am going to discuss some points of confusion that new note investors often have when they are trying to bid on them. I like to think of CFDs as similar to an auto loan. When you buy a car using an auto loan you drive away with the car, but the bank actually retains the title to the vehicle. When you buy a CFD you get the deed to the property, but you don’t have access to the property and when the borrower pays off the loan the property is theirs. You can find more detail on them here.
The nonsense with sellers sometimes comes up when the unpaid balance (UPB) is less than the BPO value of the property. You need to base your bid on the smaller of the 2 values, so if the UPB is smaller than the BPO then you cannot bid based on the value of the home.
Suppose you have this example:
- Unpaid balance: $20,000
- BPO value: $60,000
In cases like this I’ve run into some sellers who want pricing based off the BPO, so the actual purchase price for the CFD would be higher than the UPB. Their argument is that you are getting the deed, so the price should be based off of the BPO value. I’ll be nice here…. but if you do this you are basically getting robbed. It should be obvious, but I’ll point out that if you pay more than the UPB, then if the borrower pays off the loan you will lose money. So that’s why you can never ever do that. I suppose its technically possible to pay more than UPB, take the home back in a forfeiture, and then sell the home and profit on the deal. But you would need it to go down the forfeiture route and then the value of the home would have to be what you expected without bad surprises on the inside. You just can’t depend on that specific scenario happening.
The flip side is if there is a lot of equity in the deal, then that may influence the price I am willing to pay for the CFD. If there is a lot of extra value, then that lowers my risk in the event I do end up having to do a forfeiture and take the home back because I can tolerate more repairs or unexpected other problems that may come up (like the wet bandits striking). Plus if the borrowers have a lot of equity there is more incentive for them to perform on the loan. So all things being equal I might be willing to pay a little more for a CFD with a lot of equity, but I’m never basing the price solely on the value of the home.
So make sure you never pay more than UPB for a loan, or even remotely close to UPB for that matter. If someone tries to convince you otherwise its a seller you don’t want to work with anyway.