Note investing is becoming more and more popular among passive investors. The modern economy is ideal for entrepreneurs who are looking to produce multiple income streams at the same time. You can easily keep your w-2 income job and save as much as possible while investing in income-producing assets.
One of the best ways to earn passive income is to invest in something called a “note”. In essence, you will become the bank, typically for some type of real estate transaction.
What Exactly is Note Investing?
To get a better understanding, let’s first define a note. By definition, a note is just a promise to pay someone. A note, like when used for a mortgage, is usually slang for a promissory note. In addition to the loan amount, the promissory note will include the following:
- The terms of the loan
- Payment amount
- Number of payments
- Frequency of payments
- Timing of payments
- Loan rate (APR)
A promissory note is an agreement that a real estate buyer pledges to uphold the terms and conditions of their loan or mortgage.
It’s not the deed or the mortgage itself. Instead, it’s the agreement that defines the terms of the loan, such as the timing and payment amounts. Because of this, a promissory note is potentially quite valuable to the person who holds it.
Anyone who purchases a promissory note becomes the one responsible for the secured debt. Essentially, the note holder acts as the bank or lender for the transaction. Even if they didn’t supply the real estate or capital, to begin with.
So note investing is the purchasing of real estate promissory notes and/or security instruments used to guarantee loan repayment. A note investor will purchase the secured debt. They will now begin receiving the loan payments from the real estate buyer according to the terms outlined.
What are the different types?
There are two main types of notes to invest in.
Asset-backed notes are “collateralized”. This means that the lender (or the holder of the mortgage note) will receive some kind of payback if the owner defaults.
As you might expect, the collateral for most mortgage notes is the actual home in question.
Some notes cannot be asset-backed due to their nature. For instance, credit card loans cannot be asset-backed. There is no physical capital or collateral to associate with the agreement.
How Can Mortgage Note Investing Make You Money?
There are multiple ways to invest in mortgage notes and end up making a profit in the long term. Let’s go over the most common investing strategies.
Invest in performing Notes
A performing mortgage or real estate note is one relating to a loan that is currently being consistently paid back.
In other words, a performing mortgage is one that is not in default and is in good standing. Thus, anyone holding a performing mortgage note will receive passive income each month in the form of a mortgage payment.
You can purchase performing mortgage notes from sellers who’d rather have a large cash sum immediately.
Naturally, such a purchase will be at an overall discount relative to the total amount you might receive from all the months of mortgage.
So you could purchase a performing mortgage note for less total money than it will end up being worth at the end of the mortgage agreement.
What About Non-Performing Notes?
You can, of course, invest in non-performing mortgage notes. These notes are for mortgage or real estate loans that are in default.
Most of the time, you can purchase these notes from sellers that are trying to cut their losses to avoid losing too much cash, or they don’t wish to deal with the foreclosure process.
Therefore, if you have knowledge of the foreclosure process and know how to expertly sell off property at a small profit, it may be financially viable to seek out non-performing mortgage notes and invest in them.
You can usually purchase them for much cheaper than performing notes.
But where can I buy non-performing notes?
You can purchase these notes from the following sellers:
- Independent Investors
- Banks and other lending institutions
Small Business Lending
You can purchase promissory notes from small business lenders. This can be helpful if you know the market of the small business in question and can accurately assess its potential to pay back the loan over time.
Hard Money Lending
Some developers or investors will need large amounts of money to fund their various projects.
They will acquire the loans from hard money lenders that are put in a first position “lein”. This identifies the lender as the person who gets the collateral or property in the event of a default.
This identifies the lender as the person who gets the collateral or property in the event of a default.
These loans can be expensive, but you can easily come out with a win if you purchase a promissory note for one of these agreements. If the loan goes into default, you get the property and can do with it as you please.
If the property development is successful, you’ll have received the full money back on the loan according to the terms.
Should I invest in real estate notes?
Note investing is a great way to provide multiple passive income streams that you can use to fund your other projects or live comfortably once you become capable enough.
Most note investment returns provide profits of about 4% to 5% overall depending on the profitability of the initial agreement and the business or property in question.
You’re not going to strike it rich off a single note investment (unless you’re very fortunate), but having multiple note opportunities running at the same time can net you significant profits in the long term.
When it comes to hard money, they can provide even greater returns on investment. Some projects can yield returns between 10 and 20% per development, although it takes skill and some measure of luck to find investment opportunities worth pursuing.
Networking with investors who are in need of capital can pay dividends later on.
Is Note Investing Right for Everyone?
It’s a great choice if you want to work on building multiple smaller income streams that are passive by nature.
But eventually, once you’ve built up capital or saved enough money, you can invest in more and more expensive or profitable note investments and potentially supplement your retirement income.
Just be sure to pick your first investment CAREFULLY and let the snowball of success build!
- Real Estate Note Investing – by Dave Van Horn & Bigger Pockets
- Note Investing Made Easier – by Martin Saenz
- Paper Profits: How to Buy and Profit from Notes – by Joshua N. Andrews