Every investment opportunity comes with a risk involved and the aim of any investor is to reduce the risk. One way of doing so is by investing in mortgage notes. The basic definition of a mortgage note is a promissory note which is secured by the specified mortgage loan. Simply put, notes refer to written promise by a borrower to make payments of a specified amount at a specified interest rate at a specified time, preferably on a monthly basis.
Basic concept of notes
Real estate investments like buying a home are highly capital intensive and most households require a loan to finance such investments. The borrowers go to a bank or a mortgage firm to acquire the loan offered at an interest rate above the prevailing market interest rate and secured by the borrowers mortgage. Note investors on the other hand give cash to the lenders and take over receiving the monthly payments that were being paid to the previous lender. Thus, as an investor in notes, you give cash to the lender which can be a bank or a mortgage firm and in take over receiving of the payments made by the borrower on a monthly basis. Mortgage note price varies depending on factors such as perceived risk, amount of equity on the property, location and surrounding area of the property, type and condition of the property as well as elements of the notes.
Certainty in income flow is the biggest advantage that comes with investing in notes. Unlike property owners and managers who have worry about maintenance of the property, getting new tenants, repairs on the property and rent defaults, note investors avoid such hustles. It is for this reason that mortgage notes have been referred to as passive income stream since you get to earn money without putting in any input. Notes investors built their wealth by compounding their returns, or simply put investing in a second investment which can be another note.
Types of notes
Mortgage notes can either be first notes or second notes as determined by the pecking order of the claim. Pecking order is a concept in finance which denotes the order of priorities of a claim like during winding up of a company, debt holders have a prior claim to shareholders implying they (debtors) must be paid before shareholders. In regards to notes, first notes have a prior claim to second notes and in most cases, if the borrower defaults on the first note, the second note tends to bear the loss. Thus, second notes are quite unpopular as they are perceived by investors as more risk, particularly at a point when the real estate market is struggling to recover from the 2008 world economic crunch.
Why invest in mortgage notes
Other that the fact that you get to earn passive income, investing in notes puts you at a better position to gain financial independence in the following ways:
Collateral: Mortgage notes have a secured lien or simply put the property acts as collateral to the mortgage note thus significantly reducing the risk involved in making such investments. Further, since real estate properties are known to gain equity, this further reduces the risk involved in investing in notes.
Ease of control is another benefit associated with investing in notes. As a note owner, you rarely get calls about leakages, plumbing, water shortages and all other issues that comes with managing real estate projects. This gives you more time to invest in other projects and diversify your portfolio and this explains why notes are popular with leading profitable financial institutions like Bank of America and Wells Fargo. Hence, investors should buy notes in areas where they are not interested in owning or holding property since there is limited liability and responsibility that comes with owning notes. Note owners don’t have to deal with contractors, tents, maintenance and vacancies.
Profitability is another major advantage of investing in notes. Since most notes are purchased at a discount, you tend to make high returns when you make the purchase .This is particularly applicable in the case of non-performing notes since lenders are eager to dispose them off, they offer huge discounts. As an investor, you must have a predetermined exit strategy especially when dealing with non-performing notes to maximize your returns.
Since notes require less responsibility and obligation, it makes it easier to manage notes. As an investor, you can easily manage more loans as opposed to a property manager since managing properties require time, money, skills and staff. Thus, there is no limit as to the number of notes you can own. Further, owning a mortgage note gives you the privileges of a normal property owner such as: you can sell the note, borrow against the note, refinance the borrower, convert a non-performing note to a performing one, or flip the note.
Thus, if you are looking for an investment opportunity that can unlock your potential, notes should be your first priority. With moderate risk involved, limited responsibilities and obligations and high returns, mortgage notes give you a unique investment opportunity.