If you’re thinking about jumping into mortgage note investing, you may be wondering about ROI and specifically how to calculate it.
Mortgage notes can potentially deliver returns in the 8%–12% range.
Best of all?
You can earn passive income without dealing with broken toilets, sketchy tenants, or 2 a.m. emergency calls about clogged drains.
But before you dive in, you need to know how to calculate your return on investment.
The good news? Calculating ROI on a mortgage note is straightforward once you know the steps.
We’re gonna break it down in 5 easy steps that’ll have you crunching numbers like a pro.
Quick Refresher: What’s a Mortgage Note?
When someone buys a house with a mortgage, they sign a mortgage note: a legal promise to repay the loan. When you invest in a mortgage note, you’re buying that note from the original lender. That means YOU become the bank, and the borrower sends their monthly payments to you.
Performing Notes: Borrower paying on time. Returns typically 8%–12%.
Non-Performing Notes: Borrower behind on payments. Riskier, but bigger discounts.
Step 1: Gather All the Essential Note Information
First things first: you need to know exactly what you’re buying. You wouldn’t buy a car without knowing the mileage, right?
Basic Loan Details:
- Unpaid Principal Balance (UPB): how much the borrower still owes
- Interest rate and monthly payment amount
- Remaining term: how many payments are left
- Payment history
Property Information:
- Current market value
- Property type and condition
- Location
The Magic Number: Loan-to-Value (LTV)
Formula: LTV = (Loan Balance ÷ Property Value) × 100
Example: $80,000 loan balance ÷ $120,000 property value = 66.7% LTV
Lower LTV equals less risk. Shoot for under 70%–75%.
Step 2: Determine Your Total Investment Cost
You need to figure out exactly how much cash you’re putting into this deal. It’s not just the purchase price!
What to Include:
Purchase Price: Usually discounted from the loan balance. Banks want these notes off their books, so they’ll sell for less than what’s owed.
Due Diligence Costs:
- Title search: $200 to $500
- Property appraisal: $300 to $600
- Credit report: $30 to $50
- Legal review: $500 to $1,500
Closing Costs: Title insurance, recording fees, attorney fees. Typically 2%–3% of purchase price.
Real Example:
You’re buying a note with:
- Unpaid balance: $100,000
- Purchase price: $92,000
- Due diligence: $1,200
- Closing costs: $2,300
- Transfer fees: $500
- Total Investment = $96,000
See how those costs add up? If you only calculated ROI on the $92,000 purchase price, you’d be overestimating your returns.
Pro Tip: The bigger the discount you negotiate, the better your ROI. Banks typically sell performing notes at 90%–95% of balance, but you might snag 85% or even 80%.
Step 3: Calculate Your Annual Income
This is where you figure out how much money you’re actually gonna make. But you can’t just look at what comes in: You gotta subtract what goes out.
Income Side:
Annual Income = Monthly Payment × 12
Example: $850 × 12 = $10,200
Cost Side:
Servicing Fees: Unless you want to collect payments yourself, hire a servicing company. They handle collecting payments, sending statements, and dealing with borrower questions. Cost: 0.5%–1% of loan balance annually, or $25–$50 per month.
Insurance Monitoring: Making sure the borrower maintains proper insurance.
Misc Admin Fees
Real Calculation:
Using that $850/month payment:
- Annual gross income: $10,200
- Servicing fees (1% of $100k): –$1,000
- Insurance monitoring: –$150
- Admin: –$150
- Net Annual Income = $8,900
Those costs just shaved 13% off your gross income. This is why you can’t skip this step!
Step 4: Apply the Basic ROI Formula
This is what you’ve been waiting for: the actual ROI calculation.
ROI = (Net Annual Income ÷ Total Investment) × 100
Let’s use our example numbers:
- Net Annual Income: $8,900
- Total Investment: $96,000
- ROI = 9.27%
You’re earning a 9.27% annual return. Compare that to:
- Savings accounts: 0.5%–1%
- CDs: 2%–4%
- Stock market average: 7%–10% (way more volatile)
What Makes a Good ROI?
- 8%–10% = solid returns
- 10%–12% = excellent
- 12%+ = great deal or higher risk
- Under 8% = might not be worth it
See How Purchase Price Affects ROI:
Using the same $8,900 annual income:
- Buy at $89,000 total investment = 10.0% ROI
- Buy at $94,000 = 9.47% ROI
- Buy at $96,000 = 9.27% ROI
- Buy at $99,000 = 8.99% ROI
Every dollar you negotiate off the price boosts your ROI!
Another Quick Example:
Different note:
- Monthly payment: $650
- Total costs: $70,500
- Annual servicing: $900
Your calculation:
- Annual gross: $7,800
- Net income: $6,900
- ROI = 9.79%
Step 5: Calculate Your Total Return (The Pro Move)
That basic ROI only looks at annual cash flow. But you actually make money THREE ways on a mortgage note:
- Interest income: monthly payments
- Principal paydown: loan balance decreasing
- Discount capture: difference between what you paid and loan balance
Understanding Principal Paydown
Every month, part of that payment goes toward paying down the loan. You’re not pocketing this cash directly, but it builds equity in the note.
Capturing Your Discount
Remember, you bought at a discount… eventually you capture that difference.
Example:
- Loan balance: $100,000
- You paid: $92,000
- Discount: $8,000
When paid off, you receive the full $100,000 even though you only invested $92,000. That’s $8,000 in profit on top of all the interest.
The Total Return Formula
Total Return = (Total Income + Sale Proceeds – Initial Investment) ÷ Initial Investment
5-Year Example:
Starting:
- Total investment: $96,000
- Net annual income: $8,900
After 5 years:
- Interest collected: $44,500
- Principal paid down: ~$17,000
- Sell note at 95% of remaining balance: $78,850
Your total:
- Interest: $44,500
- Sale proceeds: $78,850
- Total received: $123,350
- Investment: -$96,000
- Profit: $27,350
Total ROI = 28.5% over 5 years or 5.7% annualized
The Bottom Line
When calculating ROI on mortgage notes, follow these 5 steps:
- Gather all note info
- Calculate total investment (including ALL costs)
- Determine net annual income (after expenses)
- Apply the basic ROI formula
- Calculate total return for the complete picture
With returns potentially between 8%–12%, mortgage notes offer a sweet alternative to traditional real estate investing: passive income without property headaches.
Just remember: Do your homework, run the numbers carefully, and don’t skip the due diligence.
Now get out there and start calculating some awesome returns!