FAQs

A note is a written "I Owe You" (IOU) document that spells out the agreement between a borrower and a lender. By signing the document, both parties are legally bound by the terms and conditions in the document. These IOUs come in one of two forms: Secured: if the borrower fails to repay a debt, then the lender has the right to seize a collateral (such as a house). Unsecured: no collateral is attached to the loan.

Performing note: the borrower is making payments on-time as outlined in their loan agreement. Non-performing note: the borrower is at least 90 days behind on their regular payments. Re-performing note: the borrower resumes regular payment after a 90-day delinquency. After 12 months of timely payments, the note is once again classified as Performing.

A mortgage involves two parties: the borrower and the lender. On the other hand, a trust deed involves at least three parties: the borrower, the lender and a trustee who holds the legal title to the property or collateral. Ultimately, both a mortgage and a trust deed serve the same purpose, which is to secure real estate as collateral in the loan transaction. Some States use a mortgage while other use a trust deed.

While there are different reasons why a bank chooses to sell a mortgage, the most common is that the borrower is delinquent on their payments (aka a non-performing note). Banks typically place these liabilities into a bundle or package and sell them at a deep discount. In other instances, banks may also choose to sell performing notes. This usually happens after the bank has collected interest payments for many years and they now want to use their capital for other purposes. These performing notes are often sold to other banks, mortgage lenders or investment firms at a moderate discount.

From a practical standpoint, there is no significant difference between mortgages. The terms 1st Mortgage and 2nd Mortgage describe when the physical mortgage document was recorded in the County Recorder’s office. When a mortgage document is entered into the county records and there are no other outstanding/unpaid mortgages in the country records, this is called a 1st Mortgage. Subsequent mortgages generated after this are called 2nd and 3rd mortgages, etc. If a property is foreclosed on, then the 1st mortgage gets paid off first. Any funds that are left over are then applied toward the other mortgage(s) on file, such as a 2nd mortgage.

From my perspective, notes are more secure than investing in stocks or having ownership of physical property. The notes in my portfolio are secured by solid collateral (the real estate). You have access to these notes at a discounted price—lower than the unpaid balance remaining on the note—which gives a certain amount of buffer lowering the risk of loss. When paying for a note, I recommend never paying more than the as-is market price of the property that serves as collateral for said note.

Note investors often get money from equity lines of credit on their residence or other investment properties, their cash savings or retirement accounts (such as IRAs and 401ks) & Coverdell Education Savings Accounts. Sometimes, people also choose to create a business partnership with friends or family, in order to pool their resources to purchase notes.

By investing in secured, performing notes, you receive interest payments every month when the borrower makes a payment on their mortgage.

Notes are on par with physical property when it comes to the ROI. However, where notes outshine physical property is in the minimal amount of overhead and stress. With notes you don’t have to worry about tenants, termites, repairs and other responsibilities associated with being a landlord. There are some drawbacks to note investing as compared to owning rental properties, such as property appreciation and depreciation which are common profit centers associated with rental properties that are not realized when owning notes.

There are several courses of action that are possible. In some cases, you might reach out to the borrower and negotiate an adjustment of the terms of the note (this will help them stay in the property). If the borrower is not in a position to resume making regular payments, you may be able to negotiate a deed in lieu of foreclosure - a process whereby a borrower agrees to voluntarily deed their property to the lender instead of going through process of foreclosure. In other cases, you can initiate a foreclosure and work with a realtor to sell the property.

Each State, and sometimes each county in a State, has specific laws that spell out the rights of a note holder, as well as how to proceed with foreclosures. To ensure that everything is done correctly, I work with a network of foreclosure attorneys around the country who understand the nuances of these laws. Keep in mind that the foreclosure process can take anywhere from 60 days to 2 years, depending on the State and county that the property is located in. Foreclosure costs generally cost about $1,500 – $5,000. Once again, the variance has to do with the rules of each State and county. NOTE: foreclosure is just one course of action when a borrower fails to pay.

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