Buying performing or non-performing mortgage notes is an enjoyable alternative to, and in some ways, a natural expansion of, hard real estate investment. I’ll quickly explain what performing and non-performing real estate notes are before getting into the nitty-gritty of how to buy them, but check out my article “Investing in Real Estate Mortgage Notes: How to Earn Passive Income Without Tenants or Toilets” if you want more background info.
What Is a Real Estate Note?
A real estate note, also called a mortgage note, is a promissory note associated with a mortgage or deed in trust. The mortgage allows the lender to take possession of the real estate in the case of a default, while the note is the borrower’s promise to pay back the loan.
Notes can be bought, sold, or otherwise transferred as long as there is an outstanding balance. When you purchase a real estate note, you acquire the right to receive the borrower’s future mortgage payments.
Performing vs. Non-Performing Notes
The difference between performing and non-performing notes is pretty straightforward. If the borrower is behind on their payments or the loan is in default, the note is non-performing. When the borrower has a history of paying on time and the loan has never defaulted, the note is performing.
People generally invest in performing notes when looking for a steady, passive income stream without a lot of risks (or excitement). Non-performing notes, on the other hand, open up a whole world of daring investment strategies.
If you want to learn more about how people actually make money buying notes, check out my article “5 Strategies for Investing in Real Estate Mortgage Notes” to learn more.
How To Buy a Real Estate Note
The four primary sellers of real estate notes are:
- Banks, credit unions, and other lenders
- Loan servicing companies
- Hedge funds and private equity funds
- Real estate investors like you
Lending institutions, such as banks, credit unions, and other lenders, are probably the most obvious potential mortgage note source to most people. Unfortunately, while not impossible, buying notes directly from a lender can be trickier than you think.
If you’re not running an investment firm or in the note-buying game full time, you might decide that buying directly from the bank is too laborious and costly. Most lenders won’t sell you an individual note; they’ll package a large group of loans together and sell them to someone who can shell out millions of bucks.
Loan Servicing Companies
Servicers are licensed debt collectors that manage loans for lending institutions and hedge funds. Not every loan servicing company will sell notes, but sometimes you’ll be able to buy discounted mortgage notes from servicers.
Hedge Funds and Private Equity Funds
Hedge funds and private equity funds pool money from investors, letting them amass the millions of dollars of purchasing power needed to directly buy a group of loans from a lender. Most funds have a set strategy for their notes, so they sometimes sell loans that don’t fit their parameters on the secondary market.
Notes are freely transferable, so if an owner decides to reinvest their funds, they can sell the note and transfer it to the buyer. The easiest way to get yourself in the note game is through an online marketplace. Note marketplaces allow noteholders to list their notes for sale and note investors (or aspiring investors) to purchase them.
How To Finance Real Estate Note Purchase
Many people assume you need piles of cash to start investing in real estate notes. It’s definitely easier to purchase notes if you’re flush, but it is also entirely feasible to finance them. There are various creative approaches you can take to fund or finance your note purchases.
If you’d prefer to raise or pool capital to purchase notes instead of taking out a loan, here are a few fundraising methods you could try:
- Establish a debt fund, such as a mutual fund, exchange-traded fund, or hedge fund to invest in mortgage notes.
- Incorporate new partnerships and LLCs, and use the capital invested by equity owners to buy notes.
- Crowdfund through social media, real estate crowdfunding platforms, or other online sources.
- Use money from your own 401(k) or IRA.
If you’d rather just borrow money for your note purchases, you can pursue financing from any of these sources:
- Private lenders
- Hard money lenders
- Commercial mortgage lenders
- Lines of credit
- Bridge loans
- Business loans
However you choose to buy your first note, performing and non-performing notes can be an exciting addition to your portfolio. No matter your funding and investment strategy, there’s a note plan out there that can get your portfolio where you want it to be.
What other questions do you have about mortgage note investing?
Join the discussion with a comment below.