A non-performing loan (NPL) is any loan in which the borrower has failed to make scheduled payments.

Investing in NPLs typically involves purchasing them from banks and negotiating with the borrower to resolve the debt. This is often done by foreclosing on the underlying property to recover the owed principal and interest.

Historically, the only way to invest in NPLs was to purchase them directly from banks through standard pool offerings, also known as NPL pools. The limitation with this, however, is that it requires at least $1MM to $2MM.

To make NPL investing more accessible, we recently started allowing accredited investors to invest in our NPL fund for as little as $20K. In 2024, investors in our fund saw a 57.60% net return. Here's how we achieve those returns:

1. We purchase NPLs at significant discounts: Banks cannot hold too many NPLs on their balance sheet due to compliance obligations, and because it ties up capital used to originate performing loans. So, they sell NPLs to us at substantial discounts to the payoff.
   
   
2. NPLs in our fund have high default interest rates: We purchase NPLs with default interest rates (which is the interest rate post-default) between 18% and 24%. This high interest rate accrues, or in other words, adds to the borrower's unpaid balance and eats into their equity as we resolve the debt. This is another factor behind our high returns.
   
   
3. We purchase low-LTV NPLs, protecting investors’ capital: LTV (Loan-to-Value) is a ratio that divides the unpaid loan balance by the property’s value. As we explain in more detail below, low LTV loans are safer because the borrower has more equity in the property. Most of the NPLs in our fund have an LTV below 60%, giving us a 40% borrower equity cushion to accrue the default interest rate.

This guide details our NPL investing strategy and how it allows us to earn consistently high yields.

Constitution Lending's real estate credit fund has bought and exited over $40MM in NPLs and manages 400+ apartments in the Northeast. Our fund is administered by EFSI and audited by Akram. To learn more, schedule a call with a portfolio manager.

How Constitution Lending’s Credit Fund Delivers High Yields

As we touched on above, two main components in our NPL investing strategy contributed to our fund’s 57.60% net return in 2024.

We Can Purchase NPLs for Less than the Unpaid Balance

We can purchase NPLs through our relationships with banks and credit unions for significantly less than the unpaid loan balance owed by the borrower. We realize the gains from these discounts when the borrower sells the underlying property and pays the full unpaid balance.

For example, we recently purchased an NPL secured by a multifamily home in New York City with an unpaid balance of $10MM for just $6MM. This means that if we resolve the debt within the next year, we will make a 66% gross annual return.

Banks are willing to sell NPLs to us for two reasons:

1. Banks don’t want the operational burden of foreclosing on NPLs themselves: Managing foreclosure processes requires specialized expertise, legal resources, and time investment, all of which fall outside banks' business models of originating performing loans.

2. Banks must meet certain regulatory requirements: Regulatory frameworks such as the Basel Accords and Dodd-Frank Act limit the number of NPLs banks can hold on their balance sheet.

Side note: Besides our relationships with banks, our internal sourcing system helps us find the highest-quality NPLs for sale. This system shows us every foreclosing NPL sale by pulling data from various data streams and automatically emails the court, asking about the starting bid. You can learn more about our internal sourcing system here.

Depending on the borrower’s profile and willingness to cooperate, we can increase the value of an NPL in various ways. For example, if the borrower is cooperative, we can pursue a loan modification that brings payments current, converting the NPL into a re-performing loan. This increases its value and allows us to resell it to another investor. Alternatively, if the borrower is uncooperative yet holds significant equity in the property, we may proceed with foreclosure so we can take ownership of the property through the debt at a substantial discount.

We Purchase NPLs with High Default Interest Rates

Default interest rate refers to the interest rate that borrowers pay after they have defaulted. It’s higher than the normal contract rate.

However, borrowers rarely pay this default interest rate on a monthly basis. Instead, it gets added to the unpaid principal balance. We are paid the default interest rate when we take control of the property and liquidate it to recover the unpaid loan balance.

When purchasing NPLs, we look for default interest rates between 18% to 24%. This is another avenue that allows us to achieve high returns. Here’s an example to help you visualize the entire process.

• Unpaid loan balance: $1MM
• Property value: $2MM
• Default interest rate: 20%
• If the 20% default interest accrues for 12 months ($200K), the unpaid loan balance rises to $1.2MM, leaving $800K in borrower equity.
• We still have a substantial equity margin before any loss is realized. (More on this below.)
• The borrower sells the property and uses the proceeds to pay the loan balance, which is $1.2MM, instead of the original $1MM, because of the default interest rate.

Below, we explain how we accrue this high default interest rate safely and without affecting our principal investment.

How Constitution Lending’s Credit Fund Protects Investors’ Capital

Most NPLs purchased for our credit fund have a 60% LTV or less. 

As we alluded to above, LTV is the outstanding loan balance divided by the property's value. For example, if the unpaid loan balance is $600K and the property's value is $1MM, the LTV on that loan would be 60%.

By exclusively purchasing low LTV loans, we have a large borrower equity cushion to accumulate the default interest rate as we work towards a debt resolution. Compare this to a higher-LTV loan, such as an 80% LTV loan, where the investor has a shorter period to accumulate the default interest rate before it affects their principal investment.

When we foreclose on and sell the property, our investors are paid (1) the principal investment, (2) the gain realized from the discounted purchase price, and (3) the default interest rate added to the unpaid loan balance.

Additional Benefits of Investing in an NPL Fund Instead of Purchasing Them Yourself

Investing in a Fund Is More Passive

Purchasing NPLs for banks, credit unions, or insurance carriers requires much work from the investor’s side. Firstly, they must already have relationships with these financial institutions to participate in non-performing loan sales.

Then, investors must do their due diligence and underwrite the loan documents to ensure it has a low LTV and high default rate. They must also consider factors that we won’t go into detail about in this article, such as whether the loan has a cure period and notice requirements, as this can affect their ability to foreclose or get the borrower to short-sell or surrender the deed-in-lieu.

Once investors purchase the delinquent loan, they must have the foreclosure expertise to conduct everything correctly from a legal standpoint and ensure they get paid quickly.

However, loan sourcing, underwriting, and foreclosing aren’t required when you invest in a credit fund, making it more passive. We take care of everything — you simply receive your returns.

You Are More Diversified

When you purchase whole loans, you’re less diversified. If the foreclosure process drags out or you fail to negotiate a deal with the borrower to short sell the property, you’re stuck with a loan that doesn’t pay indefinitely.

However, when you invest in a portfolio of NPLs, you spread credit risk across multiple asset types, borrowers, and locations. This means that if a couple of mortgage loans in the portfolio don’t do well, others can still generate good returns.

Your Investment is More Liquid

Although the Constitution Lending NPL fund has a lock-up period of 18 months, meaning investors can’t withdraw their money within the first 18 months, it still offers more liquidity than buying NPLs for banks or other lenders.

It takes time to foreclose on a property or negotiate a deal with the borrower. In fact, we’ve heard of deals where investors, who didn’t know what they were doing, got stuck in a foreclosure lawsuit with the borrower for more than 16 years.

Additionally, because there isn’t an easily accessible secondary market for the sale of non-performing loans, selling them to another investor can be difficult.

Investors in our credit fund can withdraw their investment quarterly after the initial 18-month lock-up period.

There’s a Lower Barrier to Entry

As we mentioned earlier, investors must have at least $1MM to $2MM in order to invest in NPLs, and they need to be an eligible bidder that meets all Freddie Mac or Fannie Mae requirements.

With a commercial real estate credit fund like Constitution Lending, you can invest with just $20K.

How to Start Investing in the Constitution Lending NPL Fund

You can invest in the Constitution Lending NPL fund in less than five minutes:

1. Create an account here and add funds through the Constitution Lending portal.
   
   
2. Verify accreditation by providing the necessary financial documents (e.g., income verification, tax returns, or net worth evidence) and completing our verification process.
   
   
3. We’ll send you a subscription agreement to your email inbox via DocuSign. You review and sign the subscription agreement.

Invest in Low LTV NPLs with Constitution Lending

If you have any questions about our NPL investing strategy or credit fund, schedule a call with a portfolio manager.