How to Buy Distressed Notes

by Daria Kelly Uhlig

Lenders sometimes sell distressed loans -- those whose owners are in default -- shortly before they auction off the properties that secure the loans. The loans are referred to as notes, and investors may purchase them at auction. Distressed note auctions work in much the same way as auctions for foreclosed properties. Although investors stand to earn substantial returns by leveraging the lenders' positions, distressed notes are not without risk. Potential buyers should understand the process before submitting a bid.

Obtain proof of funds showing your ability to pay cash for your note. Documents that may serve as proof include bank and investment statements or a letter from your bank, on bank letterhead, verifying that you have access to the amount of cash needed to close the sale.

Register at the auction website you plan to use to purchase your note. Enter the information the site requires to establish your account.

Research available notes. Search them by state or address, for example. Review the information the site provides about the properties that secure the notes. Choose the note you'd like to purchase. Accept the terms of the confidentiality agreement that prohibits you from contacting the property owner.

Review the due-diligence documents the auction site provides for the note on which you intend to bid. Due-diligence documents may include inspection reports, appraisal reports, tax data and other information that helps you evaluate whether the investment is sound.

View the property from the street or other public property that affords a view. Do not trespass. The lender that is selling the note does not own the property, so you may not enter it. You must assess the property’s condition using this informal site inspection.

Sign into the auction site to participate in the auction. Follow the site's instructions for entering bid amounts and submitting bids.

Obtain a cashier's check in the amount the seller requires as a deposit once your bid has been accepted. The listing information shows the amount you need.

Review the purchase agreement you receive after your bid is accepted. It outlines the terms of the sale. You must sign it exactly as it is. In so doing, you accept its terms exactly as they're written.

Follow the auction site's instructions for returning the contract and the deposit money to the seller. The contract is binding as soon as the seller signs it.

Tips

  • Buyers who purchase notes or real estate at auction commonly incur a buyer's premium fee totaling 5 percent of the purchase price.
  • Although a real estate broker may represent you in the sale, the seller will only pay your broker a commission if the auction listing notes that there’s a finder’s fee. Otherwise, you’ll be responsible for paying your broker’s commission.

Warning

  • Purchasing a note is not the same as purchasing the property that secures the note. You must also win the foreclosure auction to get title to the property. If another bidder wins the foreclosure auction, the return on your investment is the difference between the amount you paid for the note and the outstanding loan balance. In this case, the other bidder takes title.

About the Author

Daria Kelly Uhlig began writing professionally for websites in 2008. She is a licensed real-estate agent who specializes in resort real estate rentals in Ocean City, Md. Her real estate, business and finance articles have appeared on a number of sites, including Motley Fool, The Nest and more. Uhlig holds an associate degree in communications from Centenary College.

Photo Credits

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