Tipping the Scales of Performing and Non-Performing Notes

by | BiggerPockets.com

Not all things are created equal — a great concept to remember when beginning to evaluate the value of a note. Knowing that, let me get right into it this week.

Imagine a property purchased for $25,000 cash in Anytown, USA. That same property is sold on seller financed terms for $50,000 with 10% down, and monthly payments of $500 at a 10% interest rate. At this point, the note is said to be worth $45,000 ($50,000 – 10% or $5,000 = $45,000). What happens as the note gets seasoned, or as payments are made, helps determine if the note is “Performing” “Sub-Performing” or “Non-Performing”. Let’s look at each:

Performing: A performing note is one where the payments are made on time by the homeowner to the note holder. As mentioned in a previous post, the best way to keep track and prove that a note is performing is to keep a copy of the canceled checks, or at least a copy of the checks. This helps the valuation of your note. Speaking in general terms, a performing note can be sold on the secondary market for anywhere between 75%-100% of the current note value.

Sub-Performing: A step below a performing note is the sub-performing note. This consists of late payments received by the note holder from the homeowner anywhere from 15 days to 60 days late. The homeowner has to be followed-up with in order to stay within the guidelines of the agreed upon contract. At times real estate attorneys have to “remind” the homeowners of their duties, but overall the contract gets paid down. A sub-performing note can fetch between 50% – 80% of the value on the secondary market, as a rule of thumb.

Non-Performing: The most popular note right now with real estate investors. The non-performing note is essentially a note that is in default and can no longer expect repayment against the original terms of the note. What makes non-performing notes so attractive to a buyer is the opportunity to essentially purchase the asset at a deep discount. From there you, the investor can decide to re-work the note or take back the asset. In this tight credit market non-performing notes can be found for anywhere between 10% – 50% of the note value for residential properties on the secondary market.

Now that we know the three types of “ratings” to classify notes, let’s re-visit our example above. If we flash forward a year into the note’s seasoning, we can make some quick valuations of the note.

If it’s a performing note, the balance after 1 year will be approximately $43,500. That means the note could have a sales price of approximately $32,625 (75% of its current value) on the secondary market. Here’s how: Add the $6,000 in payments received for 12 months plus the original down-payment of $5,000 plus the sales price of $32,625, that equals $43,625.  The $43,625 you collected over the course of that year is a 75% return on your original $25,000 investment.  Not too bad!!

Compare that same performing note to a non-performing note. Assume 6 of the 12 payments over that first year are successfully collected leaving a current balance of $44,000. The note is currently uncollectible and can be sold for approximately 50% of the note value or $22,000 on the secondary market. When you combine the $3,000 in payments received for 12 months, plus the original down-payment of $5,000, plus the sales price of $22,000, you can sell the non-performing note and collect a total of $30,000 in one year for the property.  That’s a 20% return on your original $25,000 investment. Not bad either, but a huge difference from a performing note.

I would love to hear your experiences with performing and non-performing notes! Please share…..

About Author

Kevin Kaczmarek is President of Capital Blueprints, LLC. Serving a national and international client base, Kevin helps clients achieve their personal goals for long-term stability and solid financial growth through Self Directed IRA Investments and individualized Passive Income Strategies.


  1. Great articles Kevin,
    I have been curious myself how things will pan out if we are left with private lenders only. My question is are there any books you would recommend for those of us just starting out that explain the process of “notes” and starting a “self directed ira”in more detail. My husband and I purchased a rental, fixer (cash through a Heloc which we then turned into a 30 yr and currently net 450. a month) but I am always looking for other means to make a profit and add to our retirement. Also is their a typical amount that is bought as a note. We do have some cash that certainly isn’t making anywhere near 15% interest so we may want to look at it from this angle as well.
    Thanks for your insight it is much appreciated by rookies such as myself.

  2. Good source of info Kevin.
    I would like to know how did you compute $43,500 at the end of 1 year for Performing Note and $44,00 at the end of 1 year for a Non-Performing Note. Appreciate you or someone’s help.

    • The amount collected at the end of one year for a non-performing note in this example is $30,000. With you investment of $25,000. You banked $5,000.

      The $44,000 in this example is The amount that was remaining on the note when you purchased it at 50%. So you purchased it @ $22,000 + $3000 = $25,000 initial investment.

      This $5,000 that is explained in this example as gain, is assumming there are no legal fees or other fees. ect ect. Which there are almost always legal and other fees.

      In this situation, your only making 20% on your investment. NOT $30,000. $30,000 is the sale price of the note but you invested $25,000. So your making $5,000.

      I don’t know much about this type of investment. I actually only started reading about this stuff today. BUT I am good at reading and solving word problems so I understood enough to answer your question. Let me know if this helps. Thanks

  3. Keith Schneider on

    Hi Kevin. That was an informative article about the value of notes. I am associated with a private equity lender and have a deal proposal to bid at auction for nonperforming notes. I think that with the beginning upswing in real estate this is a great time to engage. The way that I could see equity capital coming into play would be to remain the principal and manage the investment and at the same time gain a huge capital base, and with the turning upward in values the return would be enough to share. Am I correct in thinking along these lines? And in the meantime rent the investments. But does an investor practising due diligence have the right to inspect the properties? What about for auctioned notes are they blind to the investor?
    I would love the opportunity to hear what your opinions are in the nonperforming note industry. My equity capital funder has half a billion dollars to invest in the right opportunity. The notes are collateralized by the underlying property correct with first mortgages?
    I would love the opportunity to hear your opinions and initiate a communication to see if we could fuse our interests into a win win relationship.
    Keith Schneider

  4. Keith, that is the great thing about real estate, there are several exit strategies…like renting the investment.

    I sell many of my cash flow notes I create in my own portfolio and all investors have 100% access to my collateral during due diligence as the collateral is non-owner occupied, performing, and is in first position. I think all these aspects are a must when conducting due diligence. Happy Note Hunting…

    Lee Carney

  5. Kelli Bristol

    In the case of non-preforming notes, high risk = high rewards. These non-performing notes are very high risk. There is NO inspecting the property and often the BPOs are commissioned by the seller of the note who wants a higher value than what may be accurate. Since the condition and functionality of the property is paramount to the value and BPOs often don’t focus on REO properties which sell for significantly less than normal sales, getting ZERO return is a very real possibility. Additionally, there are states where non-performing notes may be beyond the statute of limitations and may not be collectable at all.

    This is NOT easy money and the returns (accounting for losses) are not as they might seem. Think about it, if the bank or company selling you these notes could make the return they’re suggesting, why would they sell them rather than get them preforming? They wouldn’t!

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