Buying mortgage notes can be an attractive investment strategy if you’re seeking passive income and portfolio diversification — that is, if you know how to buy one.
Education is key with real estate note investing, and buying your first real estate note can be daunting.
But, it’s more simple than you think.
Keep reading for everything you need to know about how to buy your first mortgage note.
What is a Mortgage Note?
First things first: what’s a mortgage note?
A mortgage note is a legal document that establishes a debt secured by real property. It contains the terms of the loan, including the principal amount, interest rate, payment schedule, and consequences of default.
When you purchase the note, you acquire the right to collect payments and, if necessary, foreclose on the property if the borrower defaults.
Make sense?
Types of Mortgage Notes
Performing Notes are those where the borrower is current on payments and has a good payment history. These offer steady, predictable income but typically sell at higher prices, resulting in lower yields.
Non-Performing Notes involve borrowers who are behind on payments or in default. These sell at significant discounts but require more active management and carry higher risks. They can offer substantial returns for experienced investors.
First-Position Notes have first priority in case of foreclosure, making them generally safer investments.
Second-Position Notes are subordinate to first mortgages and carry higher risk but potentially higher returns.
Where to Find Mortgage Notes for Sale
If you’re ready to buy your first mortgage note, where can you begin? Here’s a few options.
Note Brokers and Marketplaces maintain inventories of available notes and can help match investors with suitable opportunities. Online platforms have emerged where note sellers and buyers can connect directly.
Banks and Credit Unions occasionally sell portions of their loan portfolios, particularly non-performing loans, to free up capital and reduce risk exposure.
Private Lenders often sell their notes to investors, especially those nearing retirement or looking to liquidate their portfolios quickly.
Real Estate Professionals and networking through investment groups can provide excellent sources for finding note opportunities through word-of-mouth and professional connections.
Financing Your Note Purchase
How can you pay for your first mortgage note? Here’s a few options.
Cash Purchase provides the simplest transaction structure and eliminates financing costs, but requires significant capital and ties up liquidity.
Seller Financing may be available from some note sellers, allowing you to acquire notes with less upfront capital while potentially improving returns through leverage.
Joint Ventures and Partnerships can provide access to larger deals and shared expertise while reducing individual capital requirements and risk exposure.
Common Mistakes to Avoid
Inadequate Due Diligence is one of the most costly mistakes. Always verify documents, property values, and borrower information thoroughly before purchasing.
Overpaying for Notes can severely impact returns. Stick to your investment criteria and walk away from deals that don’t meet your requirements.
Ignoring Legal Requirements can result in costly mistakes and potential liability. Mortgage note investing involves complex legal requirements that vary by state.
Poor Record Keeping can create problems for tax purposes, legal compliance, and portfolio management. Implement systems from the beginning to track all aspects of your investments.
Buying Your First Mortgage Note
Buying mortgage notes can be a profitable investment strategy if you’re willing to invest the time and effort required to understand the market (and execute proper due diligence).
If you’d like more information on buying mortgage notes, check out our Income Notes training program!