Harlow Street is a nonpaying first lien with $165,619.06 of unpaid balance on a house worth $212,000. If the foreclosure sale comes at month 10 under a non-judicial regime, the most a buyer can pay for it and still earn 20 per cent is $114,834.89. If the sale has to wait for a court until month 30, the most is $69,754.43. The courthouse takes $45,080.46, which is 39.26 per cent of the non-judicial price. Only $3,630.25 of it is the lawyers.
The usual way to price the difference between the two regimes is to add up what a judicial foreclosure costs more: a larger legal bill and more months of taxes, insurance and servicing. On Harlow Street those come to $14,400 before discounting. The price falls by three times that. The rest is not a cost at all. It is the same cheque from the eventual sale of the house, arriving twenty months later.
The floor, month by month
The floor is the maximum bid on the foreclosure path: the price at which every cash flow from purchase to the sale of the repossessed house, discounted at the required 20 per cent, nets to zero. The flows do not change with the regime except in two places. Legal costs are $6,500 in the judicial case and $2,500 in the non-judicial one, half paid at filing in month 2 and half at the sale. And every month until the sale costs $520: $425 of taxes and insurance and $95 of non-performing servicing. After the sale come three months to possession, cash for keys and repairs, four months of marketing, and a sale that nets $177,444 once the 10 per cent haircut and 7 per cent selling costs are taken off the $212,000.
Scenario
Sale month
Floor
% of UPB
% of value
Non-judicial
10
114,834.89
69.34
54.17
Judicial costs, non-judicial speed
10
111,204.63
67.14
52.46
Judicial
18
92,965.73
56.13
43.85
Judicial
24
80,785.05
48.78
38.11
Judicial, the base case
30
69,754.43
42.12
32.90
Judicial
36
59,765.28
36.09
28.19
Judicial
42
50,719.27
30.62
23.92
Harlow Street at a 20 per cent required return. UPB $165,619.06, value $212,000. Every row is a column of the Engine sheet.
The second row is the useful one. It keeps the judicial legal bill and moves the sale back to month 10, so the gap between the first two rows is what the lawsuit costs in fees alone: $3,630.25. The gap between the second row and the base case, $41,450.20, is what twenty months cost. Time is 91.95 per cent of the courthouse, before any question of what time is made of.
What the $45,080 is made of
Split the floor into its two halves: the present value of the net sale proceeds, and the present value of everything paid out before they arrive. The floor is the first less the second. Both halves move between the regimes, and they move by very different amounts.
Component
Non-judicial, month 10
Judicial, month 30
Reduces the floor by
Share
PV of the $177,444 of net proceeds
133,975.50
96,261.74
37,713.76
83.66%
PV of the higher legal bill
3,630.25
8.05%
PV of twenty more months of carrying
3,736.44
8.29%
PV of all costs
19,140.61
26,507.31
7,366.69
16.34%
Floor
114,834.89
69,754.43
45,080.46
100.00%
Discounted monthly at 20 per cent a year. The legal and carrying lines split the $7,366.69 through the intermediate scenario of the second row above.
More than five sixths of what the courthouse takes is waiting. The house sells for the same $177,444 in both regimes; it simply sells in month 37 instead of month 17. At 20 per cent a year, compounded monthly, twenty months of distance take 28.15 per cent off the present value of that cheque, and at the base-case sale month that is $37,713.76 of price. The fees and the carrying, the items a buyer can see on a cost schedule, are $7,366.69 between them.
The undiscounted totals make the same point from the other side. Gross cash paid out over the non-judicial path is $22,390, and over the judicial path $36,790: $14,400 more, of which $4,000 is the legal bill and $10,400 is twenty months at $520. Discounting shrinks that $14,400 to $7,366.69, because most of it is paid late. It cannot shrink the delay of the proceeds, because the delay is the whole of that effect.
Why the lawyers are the wrong line to negotiate
Three consequences follow, and they run against the way cost schedules are usually argued over.
The first is that a cheaper foreclosure attorney is worth very little. Cutting the judicial legal bill from $6,500 to the non-judicial $2,500, all $4,000 of it, would move the price by $3,630.25. Between month 10 and month 30, each month of court costs between $1,838.44 and $2,279.86 of price, so two months off the timeline are worth more than the whole reduction in fees. The eight months between a month-10 and a month-18 sale cost $18,238.90, or $2,279.86 a month. The six months after month 30 cost $9,989.15, or $1,664.86 a month. The cost of a month falls as the sale recedes, because each month of delay pushes back a cheque that is already more heavily discounted.
The second is that the timeline estimate is the most important number in the bid. A buyer who pays the non-judicial price of $114,834.89 for Harlow Street, and then finds that the sale comes at month 30, earns 5.88 per cent a year instead of 20. The workbook also finds the fall in the value of the house that would do the same damage to the non-judicial price: 34.76 per cent. Twenty months of court are worth as much to the price as a third of the house.
The third is less obvious and depends on the investor, not the loan. Because most of the courthouse’s effect is discounting, how much delay hurts depends on the rate the buyer discounts at. Set six months of extra court time against a valuation that comes in 10 per cent low:
Required return
Floor, base case
Six months more of court
Value 10 per cent lower
Which hurts more
20 per cent
69,754.43
−9,989.15
−9,319.00
the delay
12 per cent
92,753.53
−8,672.32
−11,897.56
the value
Harlow Street, judicial, sale at month 30. The Engine columns I and L at 20 per cent, Q, R and S at 12.
At 20 per cent, six months of delay cost more than a tenth of the house. At 12 per cent the order reverses, and the value becomes the bigger risk. Two buyers bidding the same judicial loan should therefore spend their diligence differently: the one with the higher hurdle on the court calendar of the county, the one with the lower hurdle on the broker’s price opinion.
What it means for a bid
A price expressed as a percentage of UPB carries a timeline inside it whether the buyer states one or not. The workbook tests three of them at the 20 per cent hurdle. At 40 per cent of UPB the loan still earns 20 per cent if the sale comes by month 32 and falls to 19.38 per cent at month 33. At 50 per cent it holds to month 22; at 60 per cent, to month 15. Each ten points of UPB paid, about $16,562 on this loan, gives back between seven and ten months of court.
So the practical order of work on a loan in a judicial state is the reverse of the order in which the costs are listed. Fix the sale month first, from the county’s actual recent timelines rather than the statutory minimum, and set the price from it. Then check the value. The legal bill comes last, because the whole of it moves the price by about as much as two months of delay. A seller quoting a non-judicial-state percentage for a judicial-state loan is asking for $45,080 that the house will never pay back on this timeline.
None of this means judicial loans are bad buys. At $69,754.43 Harlow Street earns exactly 20 per cent if the court is done by month 30, and the reinstatement, modification and deed-in-lieu paths of the book are all worth more than the floor. It means the discount for the courthouse is a discount for time, and it has to be taken in full.
How to reproduce it
Everything above is in Harlow_Street_and_Calloway_Tape.xlsx. On the Engine sheet, row 20 holds the floor of each scenario column: C is the judicial base case at month 30, D the non-judicial sale at month 10, F the judicial legal bill at month 10, and G, H, I and J the judicial sale at months 18, 24, 36 and 42. Row 24 holds the present value of the REO proceeds and row 23 the gross cash paid out. The decomposition is three subtractions: D24 minus C24 for the delay of the proceeds, D20 minus F20 for the legal bill, and (C24 minus C20) minus (F24 minus F20) for the carrying.
Cell E22 gives the 5.88 per cent earned at the non-judicial price, and Harlow!C20 and C21 give the value factor of 0.6524 and the 34.76 per cent fall. Columns Q, R and S rerun the base case at a 12 per cent hurdle. Columns T to Y are the percentage-of-UPB thresholds, and the Check sheet tests each of them, along with the $3,630 of legal cost (row 35) and the courthouse’s 39.26 per cent share of the non-judicial price (row 36). To price your own loan, change rows 6 to 10 of any column: the sale month, the legal cost, the value multiplier and the discount rate.
The workbooks behind this article
Every figure above is a live formula in the free companion files for
The Mortgage Note Investor. Each workbook ends with a Check sheet
setting the printed figure beside the computed one. No account and no email address.
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