What Is a Mortgage Note?
A mortgage note, also known as a promissory note, is a legal document that a borrower must sign when they take out a mortgage that compels them to pay back the loan within a certain amount of time.
The note will define the relationship between the lender and the borrower and list any terms required by the agreement, such as the monthly payment, late fees, and other relevant information.
The mortgage note is the official document that gives the lender the right to enforce the terms of the loan, including foreclosing on the house if you fail to make payments.
What Is Note Investing?
Mortgage note investing is when an investor purchases an existing mortgage from a lender, including the debt and the note securing it. The investor then becomes the new lender and can collect monthly payments from the borrower. They also have the right to foreclose on the home if the borrower doesn’t pay on time.
Many homeowners don’t realize that the note doesn’t always stay with the original lender when you get a mortgage. Lenders will often sell the debt and the corresponding contracts to other institutions or private investors. They usually do so at a discount, just to get it off their books, which offers opportunities to savvy investors.
By purchasing a mortgage note, you have the same rights as any regular lender, meaning you will receive monthly payments from the borrower but don’t have any ownership rights over the property itself. But that also means you are not responsible for the upkeep and management of the property either. So, mortgage note investing is a great way to create passive income without all the responsibilities of owning a standard investment property.
How To Make Money on Real Estate Notes
1. Buy and Hold Performing Note
There are two basic categories of mortgage notes; performing and non-performing. A performing note means that the buyer is up to date with all their payments, while a non-performing note means that borrower is in default. The simplest way to make money buying mortgage notes is to buy performing loans and collect the payments as passive income. If you can purchase the debt at a discount, you will eventually recoup your initial investment as long as the buyer continues to make payments. After that, you’ll be able to collect 100% profit until the end of the loan term without having to do much work.
2. Rehab the Note
If you want to make even more money, there are more complex strategies you may consider, such as rehabbing the note. Rehabbing mortgage notes involves purchasing non-performing loans, modifying the terms with the original borrower, and then selling the note to another investor. You can do this by negotiating with the lender to create new terms that allow them to start making payments again.
Say they had a 15-year mortgage, but suddenly they can’t make the payments. You could convince them to refinance to a 30-year loan, allowing you to decrease the monthly payment to a rate they can afford. Then, once they start making payments again, you can turn around and sell that mortgage note to another investor at a significant markup.
3. Flip the Note
Flipping notes is another strategy you may consider. You simply buy notes from a lender at a discount and then sell them to other investors at a markup. This is typically done by purchasing notes in bulk from a lender, then selling each note to other investors at the retail price. Flipping notes is a relatively low-risk way to make money by acting as a middleman. But the hard part is finding quality mortgage notes with enough value to attract other investors. So, for this strategy to work, you’ll have to study the underlying mortgages carefully and find a lender willing to sell quality loans at a discount.
4. Take Ownership of the Real Estate
Another strategy is to take ownership of the actual home and treat it like any other investment property. You can do this by purchasing non-performing notes and offering to buy the property for cash or go through the formal eviction process if the owner continues to miss payments. This process is a bit more complicated and does require you to take on the additional responsibilities of rehabbing and selling the property or renting it out. But it can be a smart way to find investment property at a significant discount.
How To Buy Mortgage Notes
You can technically buy mortgage notes from any lender that offers mortgages, including banks. However, that’s easier said than done. Most banks only sell mortgage notes in bulk to get them off their books for liquidity reasons, meaning you often need millions of dollars to purchase them. So, unless you run a hedge fund, it may be challenging to buy mortgage notes this way. Luckily there are other ways to purchase mortgage notes that are a bit more accessible for average investors.
Today, there are plenty of online marketplaces where you can buy mortgage notes. Marketplaces are the best place for beginners to look because they offer single mortgages and smaller pools that are more affordable than the bundles sold by the banks. Plus, they often feature data about the loan, such as the asking price, LTV ratio, yield, and other essential metrics. Popular mortgage note marketplaces include PaperStac, Notes Direct, and Loan MLS. But remember that you’ll most likely be paying the retail price, so if your goal is to flip the notes to other investors, you may want to look elsewhere.
Mortgage Note Brokers
Note brokers are other investors who also buy and sell mortgage notes. They will usually purchase large bundles or mortgage notes from banks or other larger institutions and then sell some of the notes to other investors. You can also find note brokers online, offering various loan types, including performing and non-performing loans. Note brokers can be a great place to find mortgage notes for sale. But be sure to analyze the underlying loans closely because there’s always a chance they’re just trying to get rid of their bad loans.
Crowdfunding is another popular way to buy mortgage notes that is even more hands-off than buying a note yourself. This is when investors pool their money to purchase a small portion of a large investment, in this case, a bundle of mortgage notes from a bank or other large lender. Many crowdfunding platforms allow individual investors to contribute a small amount of money into a fund that an experienced investor manages. They will then buy large bundles of mortgage notes and distribute the proceeds according to how much you invested. Common examples of real estate crowdfunding platforms include Fundrise and Peer Street.
How To Sell Mortgage Notes
1. Decide if You'll Sell All or Part of the Note
The first step in selling a mortgage note is deciding if you prefer a full or partial sale. With a full sale, you will sell the mortgage note in its entirety, while with a partial sale you will sell a portion of the note, and the buyer will be entitled to payments equal to their ownership. Typically, most mortgage note investors will sell a note in its entirety.
2. Find a Note Purchasing Company
Once you've decided to sell your mortgage note, it's time to find a buyer. There are a few major note-buying companies out there so it's important you consider which will be the best option for you. Depending on your needs, you can go with the company that offers the best payout or one that can close quickly and get you your cash faster.
3. Submit Your Note Info and Receive a Purchase Offer
After selecting the mortgage note buyer you want to sell to, you'll need to submit information about your mortgage note. The note-purchasing company will review this information and also look at other factors including the property owner's credit history and payment history. Once they've reviewed everything they'll make an offer for your mortgage note.
4. Wait For the Note Investing Company To Perform Due Diligence
If you accept the offer received by the note-buying company, you'll need to wait a few weeks for them to perform due diligence on the property. During this time most companies that invest in mortgage notes will typically perform a title search and get an appraisal.
5. Close the Sale
Once due diligence is completed, it's time to close the sale of your mortgage note. You'll typically need to attend a closing with a title company to complete the final paperwork, transferring ownership of the note. At this point, the homeowners will also be informed of the sale of their mortgage.
Is Note Investing Profitable?
Yes, note investing can be very profitable. But like any form of investing, you must do your homework and understand the potential risks to see consistent returns. Just because you don’t have to put time and energy into maintaining a property doesn’t mean there’s no work involved. You still have to be able to analyze deals and determine which notes show promise and which are duds.
Unfortunately, the secondary mortgage market is notoriously complex, meaning it’s tough to tell exactly what you’re purchasing and how profitable it will be until it’s too late. So, if you plan on getting involved in mortgage note investing, do your research and don’t invest more than you can afford to lose.
Mortgage Note Investing Bottom Line
Mortgage not investing can be a profitable investment strategy that doesn’t require you to take on the responsibilities normally associated with property ownership. It allows you to earn passive income or fees by selling notes to other investors without physically setting foot on a property. But, there’s no such thing as easy money, so if you want to be successful, you’ll need to do proper research and understand how the process works to know what makes a profitable mortgage note.