The Investor’s Guide to Performing Due Diligence on Real Estate Notes

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When it comes to note investing, it’s very similar to investing in real estate in that you make your money on the buy. So, it’s very important to do the proper due diligence given that you’re only as good as the data you have at the time of purchase. That data can be used to determine the likelihood of a favorable outcome with your notes, whether that means collecting a nice stream of cash flow or exiting the note deals with a positive chunk of revenue.

Obviously, due diligence varies based on the assets and class of assets that you’re looking at just like it does in real estate. The criteria we use when buying mobile home parks and vacant ground varies greatly from stuff we look at when buying single-family homes.

This is the same with note investing. Someone investing in performing notes may look at different data points than someone investing in non-performing notes, and so on.

So, what data points are note investors looking at?


Related: What Investors Should Know About the Tax Implications of Investing in Notes

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Performing Notes

With performing notes, whether it’s first or second mortgages, many investors tend to focus on four main things:

  • Borrower’s Pay History: A solid pay history is important because the longer a note pays, the odds of a default decrease, which affects a note’s classification and pricing. The same rule of thumb applies for arrears payments, which can show how financially committed a borrower is to their new payment plan.
  • Credit: The borrower’s credit, which is usually more important at origination, can also be used to study the trends of a borrower’s credit in relation to their other current bills. With second mortgages, the most important factor a credit report provides is usually the senior lien status.
  • Equity: Equity in the note backs up an investor’s capital. Therefore, if for some reason the borrower were to re-default, there are more exit strategies available, especially those that involved exiting through the property (i.e. foreclosure, short sale, deed in lieu, etc.).
  • Geography: When buying a first mortgage or a high equity second, an investor may be more concerned with geography for a variety of reasons, including determining foreclosure costs and timelines that differ from state to state, as well as demographics, population, and job growth.

Non-Performing Notes

With non-performing notes, regardless of what lien position the note is in, it’s absolutely necessary to get clear on the property value, the property itself, the borrower’s intent, and the potential deal exits.

First Mortgages

Specifically for non-performing first mortgages, due diligence items can include:

  • Value (FMV or Fair Market Value): Determining value is critical since it shows how much equity is backing the property.
  • Title & Occupancy: An investor should obtain an O&E (Ownership and Encumbrance) Report to determine liens, ownership, and occupancy status.
  • Taxes, Insurance, Municipal Liens, & HOA (Homeowner Association) Fees: Depending on the note and its location, any of these can be risk factors because said fees could be lien-able in some states.
  • Location, Comparable Property Values, & Property Condition: Also, obtaining a BPO (Broker Price Opinion) is recommended to validate location and to try and get an idea of the neighborhood and/or property condition. It can help determine occupancy and value as well.


Second Mortgages

Due diligence on residential junior liens can vary dramatically depending on the type of lien. For example, high equity second liens require due diligence similar to that of a first lien because they’re backed by equity, so these junior liens could go through a similar foreclosure process as first liens, leaving investors with a favorable outcome even if they have to exit through the property.

Related: An Introduction to Investing in Notes: Why You Should “Be the Bank”

When looking to purchase a no equity second mortgage, there are a few other factors to consider:

  • Senior Lien Status: More important than value, senior lien status and monitoring is important for all second liens but especially for no equity seconds. This is because when a borrower is current on their senior lien, it tells you two things: the borrower has a likely source of income and a desire to stay in the property.
  • Occupancy: Occupancy provides better odds for a favorable outcome since the borrower would likely want to stay in their home.
  • Fair Market Value (FMV): FMV is crucial to determine which category of note to buy at the right price. For example, an equity note would cost more than a partial or no equity note.
  • Title: Rarely pulled at acquisition on seconds since it’s normally done at origination, title is usually not a big risk since it’s usually covered contractually in the NSA (Note Sale Agreement) for lien position and validity.
  • Taxes & Insurance: These are also not as important since they’re usually escrowed and paid for by the senior lien.

Depending on the type of asset and class, an investor will eventually start to know what’s relevant and what is not. Now, the best advice is to begin track the data. As an investor, the information collected on the performance of the assets you’ve purchased will prove invaluable when making future trades.

Now you’re on to what hopefully proves to be some profitable exit strategies.

So, let me ask: What data points do you look at when performing your due diligence?

Leave your comments below!

About Author

Dave Van Horn

Since 2007, Dave Van Horn has served as president and CEO of PPR The Note Co., a holding company that manages several funds that buy, sell, and hold residential mortgages nationwide. Dave’s expertise is derived from over 30 years of residential and commercial real estate experience as a licensed Realtor, a real estate investor, and a fundraiser. As the latter, Dave has raised over $100 million in both notes and commercial real estate. In addition to his investments and role as CEO, Dave’s biggest passion is to teach others how to share, build, and preserve wealth. He authored Real Estate Note Investing, an introduction to the note investing business, helping investors enter the “other side” of the real estate business.


  1. Hugh Nelson

    Thanks Dave for the great article. I am interested in performing notes. How do I get independent verification (besides the note seller’s claims) of payment history, credit, other title encumbrances, Lien status, etc.? Do I get this from a title company? Are there public records (county assessor a websites, etc) that would provide good due diligence information? Thanks for the great experience you share on BP to improve our investing lives!

    • Dave Van Horn

      Hi Hugh,

      The answer lies in your source. The majority of note sellers are selling you assets that are placed with a 3rd party servicer, who are obligated to provide accurate information.

      It’s a trust and verify situation though, so many things you listed can be cross referenced utilizing credit reports, county clerk offices, etc. There are a variety of ways of doing so and those processes are probably an article in and of itself (so stay tuned! This is something I may cover in the near future).


  2. Ram Srinivasan

    Hi Dave, thanks for this informative article.

    The one question I can’t seem to find any details about is the mechanics of buying notes. For example if the current owner of the note is having a performing note valued at $100K paying him 8% interest. If someone had to sell this note, would they not sell it for $100K, the same price they bought it for? Or are they so desperate just to get their capital back (for other purposes) that they are willing to sell the $100K note for $90K?

    • Dave Van Horn

      Hi Ram,

      To really provide an adequate answer for this specific example, I would need more information.

      – By value do you mean payoff (as in what’s owed on the note)? Or do you mean the $100K is what an investor paid for the note?

      – What kind of note is this? A mobile home note? A land trust? A residential note? All of these trade differently.

      – What position is this mortgage in? A 2nd mortgage trades differently than a 1st mortgage, etc.

      – Also what is the pay history of the borrower? That also affects the pricing of the note.

      So with this information required, it’s easier to answer a real life deal question vs. a theoretical. Correct me if I’m wrong, but I think what you’re really asking is this: why do loans trade at a discount? The answer is due to a variety of reasons, but it usually has to do with the quality of the note (either at origination and/or after), the quality of the borrower, and quality the collateral backing the note, etc.

      I should also mention that there are many instances where an investor could sell a performing note for the same if not more than what they paid for it. For example, if a servicer turned a non-performing note into a re-performing note and sold it to an investor for $100K, the investor who purchased that note could theoretically hold onto the note for a few months, while the note “seasoned” (i.e. creating a solid pay history) and they could then flip the note for the same amount they paid for if not more due to the quality of the borrower. Another example would be where an investor purchased a no equity note and the equity came back in the marketplace. So it really all depends.

      Hope this answer helps.


  3. Don Petrash

    Hi Dave, great article! Thanks for the information. Regarding due diligence, how much information is a note investor entitled to receive? Can the investor insist on recent pictures of the exterior and interior of the property to determine value? Can the investor require the borrower’s credit score to be disclosed? How much sway do investors have in requesting information for due diligence before the seller walks away?

  4. Tim Rothermel on

    Thanks for the info Dave this is great stuff!

    I’m researching loans from a different angle than most. I’m trying to see if there is a viable way for a charitable organization to purchase 1st lien notes with the intent to forgive them outright for families that have fallen on hard times, much in the same way some organizations forgive medical debt. Is this something that has a possibility?

    Any feedback/tips/suggestions would be greatly appreciated!

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