Buying Notes at a Discount: Perfect for Real Estate Investors with Cash

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Sunday was fun, as some of us at BiggerPockets enjoyed lunch together in Hollywood. It was cool talkin’ with investors — beginners up to battle scarred vets. One of them, an incredibly intelligent guy, was using as one of his strategies, what I’ve had clients do (me too) in markets like we’re currently experiencing. What’s he doin’? Pretty simple, almost boring — and very profitable. Also, I’m not gonna go into all the numbers crunching here — just concept.

He’s buying notes at a discount.

If you’re a flipper buying your properties for cash, or even (Maybe especially?) if your strategies are longer term, buying notes can be not only far more profitable, but less sweaty too. I loved the example he used to illustrate his point.

He’d bought a note at a healthy discount. He then approached the property owner, offering to reduce the interest from 8% to 6% if he’d agree to increase the monthly payments from $750 to $1,000 monthly. This lead to the note’s value being increased — the basis for a bar bet if ever there was one.

How’s is possible to lower interest while increasing the note’s value?

The increased payments, combined with the lowered interest significantly sped up the time the note was gonna be paid in full — it was fully amortized from the start. This resulted in the note’s investor being able to quickly flip that note for a $12-15,000 profit. Took him just over a week or so. Does that work for ya?

For the record, none of this is new. It’s just not widely practiced.

But what if instead of buying the note for the note’s sake, you bought the note about to go or already into default? Look around at all the upside down homes in your area. How many local lenders, some of them (very few) private, would love to take a discount to Get Outa Dodge? Here’s the example we used at lunch, with a couple changes.

House worth $400,000 — note amount 380,000. Buy the defaulting note for $240,000. What are you options?

1. Go ahead with the foreclosure. In the process, approach the home owner with an attractive plan to get them out. Pay for them to move, and remove all dings on their credit report. That last one can sometimes be done completely, sometimes not. You, as the note owner can certainly remove anything you’ve generated.

You’ve then created multiple options.

A) Sell to a flipper for say, $300,000. Even counting some expenses, you’ve made somewhere in the neighbor of $50,000 relatively quickly.

B) Make the property perfect yourself, then sell it to the end user. Even if you sell slightly below market value, maybe $385,000, AND paid a Realtor to boot, your net profit would be in the range of $70-90,000.

C) You choose to keep the home, rent it out for market value, $2,000/month, and refinance it for roughly $235,000. At prevailing non-owner occupied rates, that allows plenty of room for it to easily pay for itself. You’re now operating on (Huge groaner pun alert.) ‘house money’, as you’ve almost completely recouped your original invested capital. Of course, you do it again. Duh.

D) This is my personal favorite. After spending maybe $10,000 sprucing things up — it was never a fixer — you sell it for market value. While in escrow you convert the sale into a tax deferred exchange. You net equity would be roughly $360,000 — possibly a bit more. That would allow you to easily acquire $1.25 Million (Possibly $1.5 Mil) in very well located small income properties in a solid growth region. In just eight to 13ish years or so, you’d be enjoying $90-100,000+ annual cash flow. (Assuming no increases to NOI ever.) You would’ve accomplished that enviable result with your original note purchase, which cost you lest than three times the amount of that lifelong annual cash flow. Moreover, your capital, even sans any appreciation whatsoever, would’ve grown to $1.25-1.5 Million.

Works for me. Does it work for you?

What if the note in question isn’t in default?

If you opt for the monthly income, you can do what the first guy did. Obtain an increase in payments in return for an interest rate reduction. Besides increasing your income, you simultaneously increased the note’s market value (Not always, but most of the time if structured correctly.). Furthermore, you’ve also moved up the date that the note is paid in full. When goin’ this route, many astute investors will convert the note from fully amortized to interest only or partially amortized, in order to enjoy a lump sum payoff at a time suiting their agenda.

Lastly, think about this one.

Make use of the concept of hypothecation. Simply put, you pledge the note as collateral for a loan. Let’s say you own a note with interest only payments at a decent interest rate, all due and payable in five years. The lender will loan you maybe 30-60% of the note’s face value at the same payment (more or less) as the note. The note payments still come to you, which you dutifully hand over to your lender. If your note was $100,000, and you borrowed $40,000, you’d make the payments for the five years. Since your loan was fully amortized, you’re paid in full. The original note comes due and you’re paid the $100,000 owed.

This maneuver isn’t a taxable event. It gets you some quick cash when you need it, but without coming outa pocket. It preserves the value of the lump sum payoff — all of which comes to you in full. Meanwhile, you had the use of the money, which no doubt made you more — or should have.

There are many more options when it comes to the use of notes to make hay in real estate investing. It’s truly one of the most productive methods I’ve ever employed. If you’re buying homes for cash, this approach should absolutely be in your arsenal.

About Author

Jeff Brown

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.


  1. Mike Grayford on

    Hi, Jeff. It was great to meet you and the others in LA.

    I would love to employ one of these strategies. I’ve found a house that is vacant and is in foreclosure. It needs work, but I’m a rehabber so that doesn’t bother me.

    I have a few questions. How do I find someone at the bank to talk to about buying the Note? Or should I contact the homeowner first? Is there a way to determine how close the property is to being sold at auction? What are the costs involved in buying a Note? Let’s say I get the Note, how do I avoid the foreclosure – do I just try to contact the homeowner and see if he’ll sell the property to me for $100 in return for cancelling the foreclosure?

    Let’s say this works, and I buy the Note and ultimately get the property. Why would I not always go this route instead of trying to buy a short sale? What are the downsides/risks?

  2. Jeff, great post! We are currently buying properties at trustee sale with cash. In the past six months we have explored the option of acquiring notes at discount. But our primary challenge has been locating sellers of notes, especially at a discount off the UPB. Any suggestions to this are greatly appreciated!

    • Hi All,
      My question seems to be along the same lines as Tom R and Mike Grayford – basically filling in some of the blanks in the strategy. I’m just getting started with researching notes as an investment vehicle. I’m contemplating an initial SDIRA capital investment of $20,000 from existing retirement assets. How do i locate, then evaluate notes? And, can someone add some color to outlining the risk vs reward in note investing scenario? Thanks! – Glenn

  3. Hey Mike.

    How do I find someone at the bank to talk to about buying the Note? — Call and ask. Different department names/people titles at each bank handling these things.

    Or should I contact the homeowner first? — Always good if you can or wish to track them down.

    Is there a way to determine how close the property is to being sold at auction? — Only if it’s listed somewhere, filed in your area courthouse determining such, or a party at the holding bank can confirm it.

    What are the costs involved in buying a Note? Let’s say I get the Note, how do I avoid the foreclosure – do I just try to contact the homeowner and see if he’ll sell the property to me for $100 in return for cancelling the foreclosure? — You buy at whatever good discount you can get from the current property value – not the unpaid balance (as they could be underwater) and it still makes sense to you.

    Let’s say this works, and I buy the Note and ultimately get the property. Why would I not always go this route instead of trying to buy a short sale? What are the downsides/risks? —Depends on who holds the note & if they want to sell it. If it’s a large-scale bank (Chase, Wells, etc.), you likely won’t be able to get the note. They usually would want large-scale pool purchases vs. singles (anyone hear or know otherwise, I’d love to know too!).

    What are the costs involved in buying a Note? Let’s say I get the Note, how do I avoid the foreclosure – do I just try to contact the homeowner and see if he’ll sell the property to me for $100 in return for cancelling the foreclosure? — Once you own the note, you are the “bank.” If the place is vacant and/or you can’t track the owner down, just follow the proper foreclosure procedures in your state…or find the homeowner and do a deed in lieu. They don’t get it knocked on their credit by you, you get the deed. Offer them something if you want, but that’s your call. If it’s already in a short sale, ring up the realtor/negotiator handling it…

    Won’t work in every single case, but an extra option to explore…as always your area/mileage can and will vary. I can state for me, I can’t usually go find homes already in a short sale, as many I’ve looked up the BOA’s, Chase’s, Wells, etc. typically are holding the note…so that avenue is out for me unless I can come up with an 8-9 figure purchasing power and toss those in with another large pool. Beyond that, I’m just getting lists of institutions in a JV I’m in and calling them up. Having some reasonable luck so far and continue to push.

    For the record, there are some 900+ banks on the “troubled” list right now (and others in rough shape but not approaching this status yet) – they’ve had consent orders, cease & desist orders, etc. filed on them by the FDIC or their regional overseer. Bottom line is many are on the hook for defaulted/bad loans and REO’s clogging up their books. Most will ultimately fail or get gobbled up by someone else. For example, I tried calling one in Arizona last month – Legacy Bank – couldn’t get a hold of the party I wanted. They just “failed” on Friday and got taken over. Good 8-figure “valued” junk on their books….

  4. Thanks for responding to my questions, Matt. I think I get the gist of most of your answers. I now have some additional questions and need to rephrase some of my original questions because I don’t think they asked what I was really trying to find out. So here goes, and any input would be appreciated:

    1. Contacting the bank: Okay, so let’s say I call and ask around and get a hold of someone who can help me. Do I simply ask them if they would consider selling the Note for the property at the specified address? Is there a special process to go through when buying notes from a bank? Do I need permission from the homeowner to speak with the bank about this?

    2. Any tips on bringing up / negotiating a price for the note?

    3. Are there any other costs associated with buying the note, such as transfer fees, recording fees, etc.?

    4. Is the note purchase done through escrow in California? If not, what is the process?

    5. Once I have the Note, is acquiring the property as simple as getting a Deed-in-lieu of foreclosure from the homeowner? Do I have to let the IRS know that I washed away the remaining principal on the Note?

    Sorry for all the questions. Obviously, I have never purchased a Note before but I’m interested in doing so. I actually have a property in mind that is vacant and in foreclosure, so I’d like to try this process on it. My goal would be to get the Note, convince the owner to transfer the deed in return for halting foreclosure, rehab the property, and sell on the MLS. Thanks for any help!

  5. OK.

    #1. You can. Again, all depends on the bank holding it. Some may sell singles, some may require a few purchases or minimum sale, some may not sell right now/only at certain times of the year, some may prefer to foreclose if already in the process, what have you. Several thousand banks and financial institutions in this country, each one runs things a bit different. No “permission” whatsoever needed from the homeowner.

    #2. Easier to look at off the bat since you know of the property already and its history/likely repairs. I wouldn’t bring up abandonment unless the bank knows about it. But, ask what they would take (“color”) on these, as they may only sell up to a certain % of a loss…of course they likely want as much as possible, but try and figure it out. All depends on the #’s and negotiations. In all actuality, you’d like to see those numbers first to know if it’s worth it, but you may have to pander a bit back and forth before you can do so. It will again boil down to what the fair market value of the property now is, especially if recently appraised.

    #3. There will be some small closing fees & the like, but very little.

    #4. If you want, or if the selling party requires it. Done in negotiations.

    #5. Once you have the note and everything is recorded OK. In fact a deed in lieu would the be the quickest and easiest method since they are signing it over to you. The offer even that you wouldn’t report the foreclosure on their credit could tip the scale in your favor. Otherwise you would have to go through the process, namely nonjudicial, of a foreclosure to obtain it.

    Again, general stuff to get an idea…lots of old topics in the forum on note stuff, or people asking about it. Nothing new, just kind of coming back to the forefront a bit as it’s getting harder to buy actual properties unless you’ve got the purchasing power. Just my bits as I continue to find stuff for this small note buying company I’m in – enables us to be direct to the lender and not some cheezy link on the chain…

  6. Thanks, Matt! I appreciate you taking the time to answer my questions. I’ve been trying to do searches regarding this on the BP forums, but I guess I haven’t been entering the best search criteria, because I haven’t found much useful information. Maybe I’ll try wading through old posts to see if I can find relevant topics.

    Good luck with your note buying company!

  7. Great article Jeff. Thanks for posting. Investing in secondary market mortgage notes isn’t new, but in the last couple years it has really gained momentum. Lenders are not giving them away, but the discounts are still very attractive. Unfortunately, it is difficult for the private investor to find notes for sale. The banks typically only sell to hedge funds and REITs, and they prefer to sell large pools. The major problem with pools is that you get the good, the bad and the ugly. It is a much safer play when you can cherry pick your assets.

    I haven’t seen any other investment that compares in terms of safety and returns.

    [Solicitation Removed]

  8. All of these investment strategy’s are great. but they don’t work unless you actually have notes to work with. My question is that of many others….. were can I find discounted notes??? Primarily im looking for discounted performing or reperforming 2nd mortgages with low balances between $10,000 and $30,000 nationwide??? I would be willing to invest anywere between $100,000 and $200,000 ? can someone please help with REAL NOTES?????

  9. We experienced the exact same story, and almost gave up trying to buy real notes. Thank goodness we kept going that extra mile. We have now partnered with an NPN Acquisition Specialist (over 17 years in the industry). Which provides us direct access with asset managers/owners, no more middlemen! Finally a simple way to Cherry Pick your 1st lien position Notes and get them for outrageous discounts. Unfortunately, they do require blocks of 500K at a time. We are trying to work with them and get the barrier of entry down to 100K, but as of now it is still 500K. If you can pony up the money it is definitely the way to go. Let me know if I can help? Dave

  10. Jeff Brown

    Hey Dave — There’s now a BawldGuy Note Fund specializing in 1st position notes. There’s no minimum purchase requirement, though to be a fund investor and secure the preferred return, you must be an accredited investor. PPR is the fund manager.

  11. Matt Lawrence

    Great article Jeff.

    With this being written 7 years ago, have there been any strategies changed from this approach? I assume there are new laws/rules that affect it to some degree but my experience thus far is limited to SFRs & I’m very interested in starting in notes if possible. Notes seem much more time efficient for an investor as opposed to owning many different physical units. Hopefully there is a method to investing approx $20k to start vs. the aforementioned 500k.

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