Notes in a Nutshell

2 Replies

I kind-of understand what notes are, but as a Millennial I'm prone to distraction and misunderstanding if the exact answer I'm looking for isn't immediately found on one of the first three links Google provides. We are conditioned to understand concepts if there is a 2:00 video that illustrates the idea with friendly images and that generic guitar strumming in the background. 

There's a book on flipping, wholesaling, and land lording here on BP, but is there something on buying notes and/or can you explain what they are and how they work (without using legal-ese or advanced financial vocabulary) in a nutshell? Thanks.

Well,  first, know that notes are not part of real estate, it is finance, real estate is the collateral for mortgages, like a car is collateral for a car loan. Car loans are not part of the auto industry, they are in the finance arena.

Collateral is the security pledged for a note that is evidence of a debt created.

The "maker" of a note is the borrower, they make the promise to pay a certain sum to the note holder or lender.

A note must have a stated amount owed, a term that allows the repayment, and a stated interest rate, the name of the lender and the name of the maker or borrower along with the date the note is made. From there, terms of a note can and usually are more involved.

The idea of the paper game is buying a note from a note holder for less than is what is owed under that obligation, the difference of the amount owed by a borrower and the agreed purchase price is the discount.

When you buy a note at a discount the interest rate stated in the note is not relevant to the note holder as mush as the computed interest rate earned on the purchase price. There is a stated amount owing, a required payment amount for a term remaining, the note investor will look at that payment being received over that term remaining and compute his interest earned based on the amount paid, not what is owing. Buying at a discount increases the interest earned by the investor.

Notes can also be sold for more than what is owed by a borrower, if the note rate of interest is higher than the rate investors demand for the same type of note, they may pay more than what is owed by a borrower, this overage paid is a premium amount.

A note is a bond, mortgages are generally exempt from SEC requirements but are securities. The finance jargon applies to notes as it does to bonds. While specifics are not always the same, the concepts remain constant in investing in bonds or notes.

Notes are not simple, those promoting the note business attempt to simplify the process to market their business, misinform or over simplify generating interest in their business. Finance is highly regulated, much more so than real estate, federal infractions can carry fines of $100,000.00 and up to 10 years in federal prison for each violation. State violations generally follow federal law and then add more restrictive aspects in dealing in paper.

Investing in notes is generally using your own money, when an investor thinks of using other people's money or even borrowed funds, they step into the shoes of a note broker or mortgage broker or banker, not an investor. Servicing loans, the collection of payments are also highly regulated and at a point state (and federal) laws will define an investor as a loan servicer, this aspect is also regulated.

Notes are underwritten or a lender assess the risks as well as the compliance necessary to be met in creating the debt. Underwriting is also accomplished or the risk assessed when an investor buys an existing note.

Notes that are being paid as agreed are "performing notes", those that have a poor credit history or the borrower is slow in paying are simply "slow pays". When a borrower fails to pay as agreed, the note is then in default and are "non-performing".

Since a mortgage requires a foreclosure process to secure the collateral if a mortgage is not paid, investors need to understand the foreclosure laws in the state the secured property is located. The investor also needs to understand deed interests and interests conveyed to a lender. Buying a note is not buying the property! You as a lender can not simply take collateral and own it as if you bought it and move in to a property or sell it and always be entitled to all the proceeds from a sale. Investors need to understand concepts of courts of equity and courts of law.

More in depth discussions fill the note forums on BP, from this you should be able to follow the concepts. Good luck :)    

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