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How to Invest in Notes | 7 Mortgage Note Investing Strategies

Note investing can be a great way to earn significant profits from real estate, without having to own physical property. Here are 7 strategies professional investors use to invest in mortgage notes

David Garner
David Garner
Published On: August 16th, 2021

7 Mortgage Note Investing Strategies

Investing in mortgage notes can be a great way to generate reliable passive monthly income. And there are also some potentially really big financial gains to be had too… if you know how to go about it!

In this article I’ll show you the top 7 note investing strategies used by investors  to earn market-beating returns from the comfort of their own homes.

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What is Note Investing

Mortgage note investing is a great way to invest in real estate without having to buy, sell or own houses. Instead of buying a house or apartment block, you buy the mortgage loan attached to it.

In the United States, mortgage notes – also called real estate notes – are freely traded on a huge secondary market worth many billions of dollars. Anyone can buy and sell mortgage notes without restriction.

When a lender originates a loan to a borrower they may then sell that loan to an investor who is looking for an asset that pays regular income. These are called performing notes because the borrower is making timely payments on the loan.

Real Estate Notes Generate Passive Income

Lenders and investors also often sell loans that are in default. They do this mostly in order to avoid costly and time consuming foreclosure proceedings. These are call non-performing mortgages. Investors buy non-performing notes at a discount to face value in the hope of turning bigger profits by modifying the terms or foreclosing the loan. More on that later!

So that’s note investing in a nutshell. All sorts of investors buy notes, from big insurance companies and pension funds, through average joe private investors like you and me! But what kind of notes should you buy? and how exactly do you go about investing in notes? Let’s find out…

Related: Note Investing 101 – Everything you Need to Know About Note Investing

What Type of Notes To Buy

Firstly, before we get into how to invest in notes, let’s clear something up. What is most often referred to as a ‘note’, actually comes in two parts – a note and a lien. As a note investor, you must consider the performance of the note, and the position/priority of the lien. Both play a big part in setting the likely value of a note and how well it suits your own investing goals.

Related: What is the Difference Between a Mortgage and a Note?

Note Performance

The promissory note is the contract between the borrower and lender. As I have already mentioned, a note is considered performing when the borrower is up to date on their payments. It becomes non-performing if payments are more than 90 days overdue.

Performing notes generate immediate monthly income, while non performing notes are bad debt

As such, investors looking for more passive income tend to opt for performing notes. Whereas investors with more time, expertise and resources tend to buy up non performing notes with the aim of creating value through loan modification, or even foreclosure.

Remember, that non-performing notes might look cheap, but they require a lot of work and knowledge to make profitable. Performing notes tend to trade at or very close to their face value, but they generate stable income from day one.

Related: Get Details of Performing Notes for Sale Delivered to Your Inbox Every Thursday

Lien Position

There are many types of liens in real estate. In terms of your note investment, you will have either a 1st position or 2nd position lien. Lien position and priority dictates who gets paid back first from the proceeds of a foreclosure sale.

A 1st position lien is settled first, and 2nd position lenders are paid back out of whatever is left. This means 1st position notes are far less risky investments because 2nd position lender may get back nothing if foreclosure sale proceeds are insufficient.

The Lien Provides Security for a Real Estate Note Investment

Taking everything into account, if you want low risk passive income, you should aim to buy performing mortgage notes with a 1st position lien. If you want to take bigger risks in the hope of turning a bigger profit – and you have the time and resources to spare – then look to buy non-performing notes in 1st or 2nd position.

Either way, Once you’ve bought your note, what you do next will be dictated by the features of that specific note. These include the borrower, loan terms and real estate. This is the real nitty gritty of how to invest in notes. So let’s take a look at some of the investment strategies you can use to maximize your returns.

Related: A Guide to Lien Position and Priority for Note Investors

Note Investing Strategies – How to Invest in Notes

Every note is different. Sometimes you might be able to flip a note for a quick buck. Other times it will be more profitable and/or appropriate to modify the loan with the existing borrower. In some cases you may be able to just sit back and collect the monthly payments right away. Here are the 7 most common note investing strategies used by private investors.

Flipping Notes

Many investors get into mortgage note investing with the aim of making a quick buck buying notes at wholesale prices to sell on closer to retail. In reality it is not quite that simple. There are lots of hedge funds and note brokers out there already doing just this, and many new investors get sucked into buying trash notes for way more than they are actually worth.

flipping notes sounds like easy work, but finding good quality notes at wholesale prioces takes time, effort and relationships

That said, you can make good money buying notes in bulk direct from lenders and reselling them to other investors IF you can find a tape of good quality loans from a lender at the right price. Buying tapes of notes from lenders requires building solid long term relationships with the sellers. This takes time and effort. Don’t expect to find good quality notes at a great price to be publicly listed for sale on the internet!

Related: Where to Buy Mortgage Notes Right Now – The Ultimate List of Note Sellers

Rehabbing and Reselling Notes

Sticking with the theme of buying non-performing notes, what most non-performing note investors try to do is rehab and resell your note as a performing note with new terms. Much like a real estate investor would rehab a property, a note investor will rehab the note, attempting to fix whatever was broken.

This note investing strategy involves modifying the terms of the loan with the existing borrower. This can be a very time consuming and difficult process. You are dealing with people that are potentially losing their home. They may be difficult to contact, or unwilling to communicate or negotiate. Sometimes they may just be straight unable to accept your new terms.

you may be able to renegotiate the terms of the loan with the existing borrower, but this is often very difficult and takes time

It takes a lot of time, effort and sometimes money to successfully turn non-performing notes around. There are different laws and rules in different States. You must be very careful not to break any of the strict regulations around dealing with loans and borrowers.

All that said, if you can buy a non performing note for 20% of its face value and successfully renegotiate the terms of the a new agreement with the existing borrower, for say 50% of the original balance you could very easily double your money – or better. Again, don’t be fooled into thinking this approach to note investing is easy, it most definitely is not!

Rehabbing and Holding

If you are thinking how to invest in notes, and you want to keep the income, you can also rehab and hold mortgage notes long term. If you choose to hold the note for the income once it is performing, you can then release some of your equity profits to go buy your next note. You can do this by borrowing against the note, or selling a partial.

You can hold your modified mortgage notes for income and borrow against them to buy more notes

While it takes a lot more work than simply just buying performing notes in the first place, this is a great way to build long-term passive income and expand your note investing portfolio without always having to add tons more cash for new acquisitions.

Own or Sell The Real Estate

When buying non-performing mortgage notes, it is often the case that you will be unable to modify the loan with the existing borrower. You may be unable to contact them, they may not want to negotiate, or it just may not be possible for you or them to come to an agreement that works for both of you. In these cases you will most likely have to either sell or take ownership of the real estate.

A borrower falls into default on a mortgage when they are 90 days or more behind on payments

There are lots of ways to do this. Of course the most obvious option is to foreclose the loan. But this can be costly and time consuming in many States. So, you may want to look at other options. These include taking a Deed in Lieu or getting the borrower to agree to a short sale. However you go about it, exiting a note investment through the real estate can be tricky. Be prepared to put in the time and resources to get the job done profitably.

Originate or Buy Seller Financed Notes

Creating and/or buying seller financed mortgage notes is a great was to add passive income to your investment portfolio or retirement account. This is something I do all the time with my own real estate investments. I create seller financed notes and sell them to note investors.

When I buy and rehab a house, I may sell the property to an owner-occupier and carry a note. I would do this if the buyer cannot get a traditional mortgage for some reason. So I will take a cash deposit from the buyer and give them a mortgage for the balance.

creating or buying seller financed mortgage notes is a great way to add passive income to your retirement account or investment portfolio

Once the buyer has been paying me their monthly payments as per the terms of the note for a while – that’s called seasoning – I will then sell the note to an investor who wants the income for their portfolio or retirement account. I get my money back (and profits) to reinvest in my next deal. The note investor gets a good quality performing note secured against recently renovated real estate.

Buy Performing Notes

Now we are getting into the more passive note investing strategies. This type of note investing is probably best for you if you want low maintenance investments that pay monthly income.

Buying performing notes is the easiest way to build passive income, providing of course you can find a source of good quality mortgage notes for sale. This is something we offer to investors in our private lending program at Garnaco. You can find out more about that here.

Performing note investments produce regular monthly income

Aside for our own notes, there are plenty of other places you can find performing notes. There are a number of online note trading platforms, note brokers, even banks and other primary lenders. As always, make sure you do your due diligence on the borrower and the real estate.

Become a Private Lender

Our final note investing strategy is a great way to originate your own mortgage notes that pay a great rate of interest. by making short to mid-term loans to real estate investors who need fast cash to buy properties, you get to set your own loans terms, and you get to choose your borrower too.

Of course, you really need to know what you’re looking at when you make a private loan. you need to be sure that the real estate value with cover your investment if your borrower defaults. And you should also be confident that the borrower’s plans for the property are realistic.

Private lending is a great way to invest passively in real estate

I use private lenders all the time to help with acquisitions for our affordable housing and long term rental investment programs. We have bought and renovated over 100 houses since 2016 using this private lender funding model, and it works great for us, our lenders, and the families who buy and rent our affordable homes. You can find out more about that here.

So you wanted to know how to invest in notes? Well, that’s all 7 note investing strategies covered. We’ve looked at how to invest in notes of all types, and hopefully now you will have some idea of the kind of things you can do to maximize your profit potential when you get into note investing.

Conclusion and Resources

Informed investors make better decisions. If you want to learn more about how to invest in mortgage notes and other investments that generate monthly income, you can further your research using the following resources: