Introduction to Note Investing: The Basics
Note, Mortgage, Deed of Trust…Some Terminology
A promissory note (a “note”) is a debt instrument, a contract in which a borrower promises to repay the lender, according to specific terms spelled out in the document.
A “mortgage” or “deed of trust” (depending on the state) is the security instrument, and formalizes the collateral given by the borrower to the lender to secure the lender’s position.
In the note-buying business, sometimes the terms mortgage and note are used interchangeably….”we buy notes,” or “we buy mortgages.” It is more correct to say that we buy notes, but in reality, both statements are accurate, because we buy both. The two documents–a mortgage and a promissory note–go hand in hand. We buy a note (which gives us the right to receive the payments made on the note) and we also get the mortgage (the lien on the property which secures the loan.)
Buying Notes
Essentially, when we buy a note, we become the lender. We become the “mortgage company.” That means that we receive the payments, and we can also do all of the other things that a bank or mortgage company does with a loan, including:
- renegotiate the terms with the borrower
- approve a short sale
- resell the note to another investor
- accept a deed in lieu of foreclosure
- foreclose on the property
Performing Notes
Some investors are looking for a consistent, reliable, fixed rate of return, and for this purpose, performing loans are ideal. Performing notes can be bought at a small but significant discount from face value, so the rate of return is much higher than the interest rate paid by the borrower.
Non-Performing Notes
Other investors want to make dramatically higher profits. This is often achieved by investing in non-performing notes, which are highly discounted notes. For example, today I am closing on a small note with a face value (principal owed) of nearly $50,000. I am paying $16,500 because this is a borrower who has had some issues.
If the borrower makes his payments as expected (he is motivated to keep his house) I will make a fixed 31% return on my investment, which is a great rate of return. But if he sells the property or refinances the loan, since the face value of the note is $47,000, my returns will be much, much higher!
And if he just stops making payments and won’t sell the property, I will have to foreclose and sell the property myself. That is the lease desirable outcome from a humanitarian point of view, but as a pure dollars-and-cents issue, it is another very profitable exit strategy.
How to Invest in Notes
There are many ways to get into note investing.
You may choose to make the financial and time commitment to invest in your own training and education, to find sellers of notes, to negotiate purchase price, to buy and insure notes, to set up RESPA-compliant servicing for your notes, etc.
But the simplest way is to partner with a company which specializes in locating, buying, managing, and exiting notes for maximum profitability.
We at NoteBuyingPros are prepared to partner with you in a variety of ways, based on your objectives and interests. Please contact us for details.
