What is Mortgage Note Investing?

When you buy a house, you get a loan and make monthly payments on it. That’s a Real Estate Note. What many folks don’t realize is that these notes are actively traded behind the scenes. Have you ever received a letter telling you to send your payment elsewhere? Your loan was simply sold to another lender.

When a loan is sold, all the rights associated with that loan go along with it. Because it is “secured” by the underlying property, the new lower of the loan can foreclose if the loan is not paid.

Investing in real estate notes is generally the purchase of an existing mortgage. And when you purchase a mortgage note, you become the lender. You have all the rights of the lender. You don’t own the real estate, but you have a right to take the collateral if the borrower doesn’t pay.

The two broadest classes of Real Estate Notes are commercial (e.g., apartments, office space, industrial, etc.) and residential (single family homes). For the purposes of this guide, we will focus on the latter.

Intuitively, investors understand that it’s good to be the bank. That’s one of the reasons why there is a bank on every corner. And in this case, when you invest in notes, you become the bank.

When investing in rental real estate, most investors become a landlord, but it’s better to be a “Lien-Lord.”

When you invest in real estate notes, you get all the advantages of being the bank, without the headaches of being a landlord. And you have a lien that collateralizes your investment.

As a landlord you are always concerned with the Terrible T’s (Tenants, Toilets, and Termites). As a lender, you are less concerned with these, as they are the responsibility of the homeowner. Here are a few of the advantages to investing in notes versus other real estate assets:

1. No Property Management – Many investors have turned to real estate to create cash flow, but managing rental properties can be time-consuming and riddled with problems. Being the lender means you receive the income, while someone else manages the property.
2. No Maintenance Issues – Every homeowner knows what it’s like for something to break and be on the hook for the cost to fix it. As a lender, all maintenance is the responsibility of the homeowner.
3. No Managing Tenants – Whereas rental property owners are concerned about vacancies in their rentals, the homeowner must continue paying the mortgage or you can take back the property through foreclosure.
4. Lien Secured by Real Estate – Mortgage notes are secured by the property, meaning if a borrower suddenly stopped paying their mortgage, you have the rights to foreclose and take back the property.
5. Mailbox Money – If you do your underwriting correctly, we haven’t found many investments that can provide income that is as passive as mortgage notes.
6. Liquid Secondary Market – An active secondary mortgage market means there is a strong appetite for mortgage notes, allowing investors to sell their notes without incurring the selling costs or opportunity cost of exiting real estate.
7. Discount– Perhaps the greatest advantage of investing in mortgage notes is the discount at which buyers can purchase notes. As mentioned before, banks generally aren’t well equipped for these types of notes. Discounts create higher yields, greater profits when paid off, and additional capital protection.