Looking to get started with real estate promissory note investing? Learn the facts about this little-known method of creating wealth with reliable, cash flowing assets that beat stock market returns.
Real Estate Notes 101
When someone buys a house and does not have the finances to pay cash, they borrow money from a bank or mortgage company, known as the lender. The lender will have them sign two primary documents. One of those documents is the promissory note (which is an “I owe you”) and the other document is a mortgage.
A mortgage note is the promise or agreement a borrower makes to repay a lender. A mortgage, also known as a deed of trust is a legal document that gives a bank or lender authority to seize a property or other type of collateral if a loan is not paid.
Some form of collateral, in this case real estate, is always attached to these payments. Therefore, if the borrower (homeowner) ceases making payments, a lender can obtain ownership of the property.
The mortgage states that if payments are not made as indicated in the promissory note, the lender can assume ownership over the property. After both documents are signed, the lender will release their funds to the borrower so they can purchase the property.
The Basics of Promissory Notes
Overtime, the lender will collect monthly payments from the borrower. In some instances, lenders would prefer to have a lump some of money immediately as opposed to the monthly payments. This could happen if the borrower sells the property or refinances the property, they can pay off the lender. However, the lender cannot control if or when the borrower sells or refinances their property.
Therefore, the lender can decide to sell the real estate promissory note. They use a process to transfer the mortgage and the note from their company to another institution. That transfer process is regulated by the federal government.
The homeowner receives notification that their loan has been transferred to another recipient (lender). The homeowner will then begin making payments to the new lender.
The terms of the loan are not negotiable for the new lender since they agreed to what the original lender had on file. So, it is important for the new lender to make sure that they are satisfied with the current terms in the note.
Who Are Private Mortgage Note Sellers?
Banks are not the only lenders when it comes to homeownership. Private sellers can also “become the bank” and originate new loans and hold the notes on properties. Typically, this arrangement works when a borrower is unable to obtain a traditional loan from a bank due to poor credit history or when a home seller is unable to sell their home due to a challenging real estate market.
Just like a bank, the private mortgage holder does not have to deal with the hassles of property maintenance, tenants, toilets, and trash. They simply are the lender for property – they are not the landlord.
In this scenario, note sellers can collect monthly payments from borrowers just like banks and other larger lending institutions. Private sellers are usually less stringent in qualifying borrowers than typical banks. They will work with borrowers who have difficulty qualifying for traditional loans.
Just as banks and other larger lenders sell ownership of mortgage notes for profit – smaller private mortgage note holders can do the same. Private note holders can sell their promissory notes to other investors.
There are a variety of ways to make money in the mortgage note investing space. You can purchase notes from these private sellers, hedge funds, or directly from banks themselves. There are also online marketplaces where you can buy notes.
You can also partner with other investors to take a portion of the profit from the sale of a note also known as a joint venture. If you prefer more hands-off approach to investing, you can even fund or loan money to an investor for them to purchase a note and receive your money back with interest added.
How Much Money Is Needed to Get Started as a Note Investor?
The amount of money needed to begin your journey as a note investor is not as much as one would think. While they may be big investments, you do not necessarily need $200,000 to buy a mortgage note. In fact, in some parts of the country, mortgage notes will cost as little as $35,000 or less.
You may even find some notes that may cost as little as $1,000. However, you must be careful about very low-cost mortgage notes because the associated properties may be in high crime areas. In the event a borrower stops making payments, you as the lender will take ownership of the property. If you are not prepared to own a property in a high crime area, you may want to avoid these notes.
To get started, you should buy mortgage notes that are at least $30,000 and first position notes, occupied cash flowing notes. Ideally, you should buy notes that are between $50,000-$150,000, since you will have a better chance at generating a good return on your money. You will want to have a nice property as collateral with working borrowers who you can rely on to make their payments every month.
Interested in commercial property notes? Individuals who can make larger investments can buy notes on commercial properties such as hotels, manufactured home parks, and multifamily units. The benefit to being a mortgage note investor, is that the real estate is valued at a substantially higher prices than your investment.
Using Retirement Accounts to Buy Real Estate Notes
Have an old IRA sitting around getting poor returns? Well, you can use those funds to purchase mortgage notes! In fact, note investing is a much safer, secure way to save for a profitable retirement as opposed to traditional stock investing.
Remember, the mortgage is secured by real estate. If a borrower does not pay back the loan as agreed, a possible outcome for a lender is to foreclose and seize the property which has inherent value. With traditional IRA/401k stock investing, there is little to no recourse if the stock market tanks. You are simply out of luck.
In order to use a retirement account to invest in notes, you simply have to convert it to a self-directed account. There are many self-directed account custodians to choose from.
In closing, real estate promissory note investing is a great way to build a cash rich portfolio of assets.
You May Also Want to See:
- CFD vs. Mortgage/Deed of Trust – What’s the Difference?
- Unlocking Cash Flow: Harness Mortgage Note Investing and Be Your Own Bank
- Demystifying Mortgage Note Investing: How to Get Started Now!
- 8 Ways to Make Money with Real Estate Note Investing
- Struggling Wholesalers to Thriving Note Investors – Our Story
