Investing in mortgage notes is an alternative way to invest in real estate for people seeking passive income. Although this niche industry requires a lot of research and due diligence, it is significantly less hands on than owning a rental property, while granting you more freedom and control than investing in the stock market. These are just a few of the perks that come with note investing.
Here are 10 reasons why you should invest in mortgage notes:
1. Discounted Pricing
Both performing and non-performing notes are almost always sold at a discounted price, although non-performers will likely sell for a greater discount than performing loans. This means that you will be able to purchase the note for significantly less than the principal balance. Typically, you can purchase a non-performing mortgage note at anywhere from 20 – 65 percent off from its current loan balance. Performing loans are sold at a discount where the investor may obtain an 8-12% yield as long as the loan continues to perform.
2. Collateral
Another benefit of investing in mortgage notes is the collateral that is tied to the investment. For first-position mortgage notes, the property itself is used as collateral. The borrower will likely be more motivated to continue making payments if they have built up equity in the property. However, if the borrower is no longer making their monthly payments, the investor can go through a legal process called foreclose to request the property be sold in order to receive the monies the investor is owed. If a property goes through foreclosure, it may be sold to a third party or back to the investor who would then have the option resell or create another note. The fact that a mortgage note is a secured asset with collateral behind it makes for a great investment choice.
3. Diversification
Something that makes mortgage note investing unique is the fact that the performance of your investment is not tied to the stock market. This means your investment will not be affected when the stock market increases or decreases. So often we blindly invest in stocks or sign up for our employer’s 401(k) plan and hope for the best. When it comes to investing, diversification is a good thing and having some of your funds in an asset class that is not tied to the stock market can be extremely beneficial. With note investing, the only factor you need to worry about is the employment status of the borrower, as this directly effects their ability to make payments. If people have jobs, they typically pay their bills.
4. Control
One of the best parts of investing in mortgage notes is the control you can have. Not only do you get to evaluate the asset that you buy, but you are also in-charge of managing it and developing a plan to move forward. When you purchase a note, you essentially become the bank, and each note becomes its own separate business. This means you as the note holder have sole influence over how your note business will operate. While this does take more work than investing in stocks, it can be reassuring to have that insight and control over your investment and financial future.
5. Multiple Exit Strategies
Unfortunately, nobody has full control over the way a deal might go, but the good news is that you are not always backed into a corner. If a note goes south, you have a multitude of possibilities when it comes to exit strategies. For a performing note, the investor might choose to hold the note for cash flow, sell a partial to another investor, or just sell the note entirely. There is also a chance that the borrower might refinance, which would grant the investor immediate profit since you are getting a full payoff.
For a non-performing note, you can extend the timeframe the homeowners have to pay back the loan so that you can lower their monthly payments. If the payment is lowered, the homeowners might be able to start making them again and the note will be back to performing status. If this option fails, and the borrower no longer wants the home, an investor may offer a borrower “cash for keys”, whereby you pay the borrower monies to sign the property back over to you. Once the investor owns the property, there are several options to turn a profit. You can choose to sell it as is to another home buyer, you can sell it to a “fixer upper” investor, you can rent it out, or you can flip it.
6. Numerous Types of Notes
Note investors can approach this business in a plethora of ways as there are numerous strategies and directions you can take. This is primarily because there are many different types of notes, all of which perform differently and require different strategies. To put it into perspective, here are just a few options one might decide to invest through: performing notes, non-performing notes, firsts, seconds, seller financing transactions, institutional notes, land contracts, commercial notes, hard-money loans, and note funds. Think of each type of note as a different credit card. Just like notes, we often have different credit cards for different reasons.
7. Opportunity on the Horizon
While it is quite unlikely that there will be another mortgage crisis like we saw in 2008, many signs point to a new correction on the horizon. Although market corrections are damaging in the short term, the outcome produces vast buying opportunities by adjusting overvalued asset prices. When a correction takes place, banks and hedge funds will be apt to sell off non-performing and sub-performing notes. Because of this, supply will go up, ultimately causing prices to drop. Since mortgage notes will become less expensive, the potential returns will vastly increase. With this being said, there is so much opportunity in this space.
8. Ability to Scale
If you are looking to invest, one of the benefits of choosing mortgage notes is the ability to scale. This is significantly easier with notes than it is with other forms of real estate. While you can choose to purchase a couple mortgage notes and leave it at that, you have other options as well. A more passive route would be to partner with a more experienced investor, whereas a more hands on approach would be to treat your notes like a business. Once you do the initial work of getting all your systems and vendors in place, it becomes relatively easy to replicate this process for future ventures. While note investing absolutely requires hard work and due diligence, it can be broken down into these 3 steps: finding notes, finding money, and then managing your notes and money.
9. Ability to Invest from Anywhere
One of the best parts of this business is that you can invest in mortgage notes from anywhere. Since location is not a factor, you can invest wherever the numbers make the most sense. Unlike owning a rental property, you are not required to do maintenance on the home as you are not the homeowner, you are the bank. You never need to go to the property so there is no need to be located near it. However, on the rare occasion when an issue does take place, note investors have what are referred to as mortgage servicers and property preservation companies to deal with such situations. Many note investors have never been to any of the properties that back up the notes they own, including myself. As long as you have an internet connection and a cell phone, you can invest in notes.
10. No Tenants, Toilets, or Termites
If you compare note investing with being a landlord, one is a lot more passive while the other is a lot more hands-on. Both can be great investments, but owning a rental property surely comes with more headaches when you consider the tenants, toilets, and termites that come along with it. Phone calls in the middle of the night, plumbing issues, bug infestations – these are just a few occurrences you are bound to run into as a landlord. Being a note investor comes with no maintenance because you are dealing with the paper as opposed to the actual property.