Morgage Notes

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Mortgage Notes

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A mortgage note is a written promise by a borrower to pay a certain sum of money to a specific lender over a stated period of time at an agreed upon interest rate. The mortgage (amount that is owed) is typically secured by an asset (real property). A mortgage note often includes a promissory note, which stipulates that if the borrower stops paying the loan the lender has the option to take the property as payment. If the property is no longer worth enough to pay off the loan, then the borrower will still pay the loan through the use of other assets.

The most common mortgages are for single family homes written through banks. The process starts with a prospective purchaser (soon to be borrower/buyer) identifying a property they would like to own. After getting a contract (purchase agreement) to buy the property (typically through their real estate agent), the now borrower approaches a lender (their bank, mortgage broker, etc.), where a process called “Underwriting” occurs. The lender looks at all of the details of the purchase agreement. They look at the buyer to determine how credit worthy he/she is. They look to make sure he/she has sufficient earned income from a job or business to make the monthly mortgage payments. They review his/her current expenses to make sure that he/she will have enough money after all her other bills are paid to also pay the mortgage.

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The lender inspects the property to see that it is actually worth what the parties agreed. Once satisfied, the lender makes the loan. This process is called loan origination.

Once the origination is complete, banks and other lenders may sell these loans to a secondary market. They do this for several reasons. The first is that they do not have enough long term capital on hand to hold all of the notes. The banks borrow large amounts of money, but only for short periods of time. When they sell off the mortgage in the secondary market they repay their loan. They may also sell the loan to generate more cash, so they can take advantage of a different investment opportunity. Yet another reason to sell the loan is that it no longer fits into their portfolio strategy.

When loans are sold the terms do not change.

I buy these loans.

Loans fall into a couple of categories. They are either performing (borrower is paying) or non performing (borrower is behind in payments). They are also either 1st mortgages (the top mortgage lien on the property) or 2nd mortgages (a mortgage taken out and recorded anytime after the 1st loan). An example of a second mortgages might be a home equity loan.

Performing loans are purchased for the income stream they pay. It is similar to owning a rental property, where you receive an interest payment every month. You also receive a small return of your principle in the payment.

Non performing loans are purchased with the intention of getting them to perform again through some type of restructuring of the loan. This is also known as a loan modification (loan mod). This can produce the greatest return on investment (if that’s your goal) by in turn re-selling this as a performing loan. If you are unsuccessful getting the borrower to do a loan mod your exit strategy is to foreclose on the property.

Notes are normally sold at a discount, with the greatest discount afforded to non performing 2nds. Because all other terms of the loan remain the same, specifically the monthly payment, buying the loan at a discount has the effect of receiving a higher interest rate.

If you are looking for a somewhat predictable cash flow, you would normally purchase a performing note. If your objective is to acquire a property at below market prices, you would purchase a non-performing note and start the loan modification process and subsequently the foreclosure process if the borrower can’t perform.

In my opinion, you should never purchase a mortgage note unless you are comfortable owning the property that is the collateral. A performing note could become non-performing at any time so be prepared and have a plan.

I am here to help! It is my experience in tax liens, land lording, and flipping that makes me a great partner for this type of investment.

Call me today at 609.529.3549 to explore how we can work together.

The following mind map outlines the note investment process.