Mortgage Notes: Unlocking The Power Of Passive Income

Investing in mortgage notes is an alternative way to enter the real estate market without purchasing properties. When you buy a mortgage note, you become the creditor of the borrower (home purchaser). You receive monthly income in the form of principal and interest repayments on the underlying mortgage.

Mortgage notes are typically broken down into the following categories:

- Secured: An asset of some value collateralizes the loan.

- Unsecured: There is no collateral posted. These notes typically come at a cheaper price (higher yield) because of the higher inherent risk.

- Private loan: This is a note agreed to between the borrower and a private investor.

- Institutional loan: This is a standard loan made by a financial institution such as a bank or credit union.

There are two broad categories of residential real estate notes you can invest in:

1. Performing notes: These are notes where the borrower is making their scheduled payments. As an investor, the primary focus is on current income.

2. Non-performing notes: These are generally sold by banks and other financial institutions and are sold at significantly deep discounts, perhaps between 50-90%.

There are several ways to buy mortgage notes:

- Purchasing existing notes: Both performing and non-performing notes are available for sale on the secondary mortgage market.

- Investing in a fund: Many investors prefer a more passive approach and partner with Fund Managers to outsource the active management of these assets.

- Creative financing techniques: This includes seller financing, partnerships, or leveraging other assets as collateral.

Understanding mortgage notes

A mortgage note, or promissory note, is a legally binding agreement that establishes the borrower's commitment to repay the loan. It includes key terms such as the principal amount, interest incurred, foreclosure possibilities, and late payment implications.

Mortgage notes can be categorised into performing and non-performing notes. Performing notes represent loans where borrowers consistently make their payments, offering a steady income stream and lower risk for investors. Non-performing notes, on the other hand, are loans with missed payments, presenting higher risks but also potential for greater returns through foreclosure or loan restructuring.

The value of a mortgage note is influenced by factors such as the borrower's payment history, credit score, and the underlying property's value. The property serves as collateral, providing a safety net for investors in case of default.

When investing in mortgage notes, individuals essentially become lenders, receiving monthly interest and principal payments. This form of investment allows individuals to benefit from the real estate market without owning physical properties, avoiding the hassles of property management and tenant issues.

Before investing, it is crucial to understand the risks and conduct thorough due diligence. This includes evaluating the borrower's creditworthiness, reviewing the loan agreement, and assessing the property's condition, location, and market value.

In summary, mortgage notes offer an alternative path to real estate investment, providing the potential for steady income and capital appreciation without the direct involvement in property ownership.

Finding mortgage notes for purchase

Mortgage notes are available for purchase on various online platforms and auctions. These digital marketplaces provide detailed information about the note holder, property, and terms. It is crucial to conduct thorough research and due diligence before making a purchase. Popular platforms include NoteMKT and Paperstac, which offer a wide range of notes from banks and other financial institutions.

Networking with industry professionals is another effective strategy for discovering note sale opportunities. Joining relevant associations such as the Mortgage Bankers Association (MBA) can provide valuable insights and connections. Attending conferences and seminars related to real estate financing also helps build relationships with potential note sellers.

Public records and legal notices are also useful sources for identifying potential note purchases. Investors should look for notices of default or foreclosure actions in county record offices. These documents indicate that a bank may be willing to sell the mortgage note. Legal notices published in newspapers or online can also lead to finding distressed notes that banks are eager to offload.

When purchasing mortgage notes, it is important to assess the borrower's creditworthiness and evaluate the underlying property. The condition, location, and market value of the property directly impact the note's worth. Additionally, investors should consider repair needs and depreciation factors, as these can significantly alter the purchase price.

Another option for finding mortgage notes is to work directly with banks or bill purchasing companies. Banks often package mortgage notes into bulk sales, allowing them to manage their portfolios efficiently and attract institutional investors. By establishing relationships with the asset management or special assets departments of banks, investors can gain access to distressed or non-performing loans, often referred to as 'note' sales.

In summary, finding mortgage notes for purchase involves a combination of online research, networking with industry professionals, evaluating public records and legal notices, and working directly with financial institutions. Conducting thorough due diligence and assessing the underlying assets are crucial steps to ensure a successful investment.

Due diligence before buying

Due diligence is an essential part of the process when considering investing in mortgage notes. It can help you identify potential risks and opportunities associated with a particular note. Here are some key factors to consider when conducting due diligence:

• Underlying Collateral: The type of real estate the note is attached to (vacant land, commercial property, or residential property) will impact the due diligence process.
• Equity in the Property: If the note value is significantly below the property's market value, it provides a safeguard if the borrower defaults. It is riskier if the note's value is close to or exceeds the property's value.
• Property Locality: The location of the property is important as it affects the property's ability to retain its value and the regulatory environment. Some states have more favourable conditions for lenders, while others have shorter or longer foreclosure processes.
• Borrower's Ability to Pay: Analyse the borrower's pay history and overall creditworthiness. Even if they face financial difficulties, a borrower with a long history of successful loan payments is more likely to continue making payments.
• Establishing Value: Get an idea of the property's value by using online tools and speaking to local real estate agents. Focus on a range of values rather than specifics and think in terms of the After Repair Value (ARV).
• Reviewing Digital Documents: Examine the financial statements and digital documents, including the collateral files, credit report, chain of assignments, and any modifications made to the original terms.
• Payment History and Servicing Notes: Go through the payment history to establish a story for the note and learn about the borrower's payment habits. Servicing notes will also tell you about potential exit strategies.
• Collateral File: Before making your final offer, review the original collateral documents from the borrower, including the note, mortgage, assignment, and allonge.
• Titles and Property Taxes: Order an Owner & Encumbrance (O&E) title report to aid in your due diligence. Review and ensure all property taxes are paid and up to date.
• Broker Price Opinion (BPO): Contact a local real estate agent or get a BPO to help verify the value and examine the property.
• Foreclosure Laws: Understand the foreclosure laws in the state where the asset is located.

Remember, due diligence is an ongoing process that safeguards your investment. It is crucial to make informed decisions and minimise risks when investing in mortgage notes.

Investing in a fund

Many investors prefer to take a more passive approach and partner with Fund Managers when investing in this asset class. By doing so, you eliminate the need to be involved in the active management of these assets, diversify your risk across many assets and geographies, and leverage the expertise of their team.

• Leverage the expertise of experienced managers with a track record and experience in real estate
• Actively managing assets is a lot of work; outsourcing frees up your time and energy
• Deal flow – one of the biggest challenges for active investors is keeping capital deployed
• Liquidity – unlike other real estate investments, there is an active secondary market, and some Funds allow liquidity after 1 year

Whether you're curious about investing in notes yourself or partnering with a Fund Manager, it is recommended that you speak with a professional to help point you in the right direction.

Advantages of investing in mortgage notes

Investing in mortgage notes can be a great way to generate passive income without the hassle of owning physical property. Here are some advantages of investing in mortgage notes:

Passive Income

Mortgage note investing offers the potential for passive income. When you invest in mortgage notes, you become the lender, and borrowers make regular payments to you, providing a consistent and predictable income stream. This can be an excellent way to build wealth over time with minimal effort.

Lower Entry Costs

Real estate investment often requires substantial upfront costs, such as down payments, closing costs, and ongoing expenses. In contrast, mortgage note investments typically have lower entry costs, making it more accessible for novice investors or those with limited funds.

Reduced Risk

When you hold a mortgage note, you have a secured interest in the property. This means that if the borrower defaults, you can potentially foreclose on the property and recover your investment. This provides a level of protection that physical real estate investments may not offer.

Geographic Flexibility

Mortgage notes can be obtained from various regions or even different states, allowing you to diversify your portfolio and take advantage of opportunities in strong real estate markets or areas with more affordable housing.

Reduced Operational Hassles

Real estate investments come with operational responsibilities such as property maintenance and tenant management. Mortgage note investing eliminates these hassles as you are not responsible for the property's day-to-day operations. This frees up your time and reduces the stress associated with property management.

Greater Liquidity

Mortgage notes are generally more liquid than physical real estate. They can be bought and sold more easily and quickly than physical properties, allowing you to adapt to changing market conditions and capitalise on opportunities in real time.

Diversification

Adding mortgage notes to your investment portfolio helps achieve greater diversification by spreading your risk across different asset classes. This reduces your exposure to any single market or asset class, making your overall portfolio more resilient.

Frequently asked questions