Investing in real estate notes or mortgage notes is one way to generate passive income in real estate without dealing with a property or brick-and-mortar building. Once you buy mortgage notes, you immediately become the lender of the borrower, in which you’ll receive monthly payments. Buying real estate or promissory notes can be a great investment if you’re looking for a passive and consistent income stream secured by real estate.
But, how do mortgage notes really work, and benefit investors and borrowers? Get answers for such questions by reading below.
1. How Mortgage Notes Work
When you’re investing in mortgage notes through a bank, it involves purchasing debt at prices below what a borrower would usually pay. For example, if the borrower’s debt is USD$25,000, the bank can offer you a lower lump sum amount through mortgage notes. So, when the borrower makes payments, you’ll receive the money because you’re the new owner (lender) of the real estate notes. If the borrower defaults on payments, you can contact them to make new arrangements on how to repay what they owe.
2. Risk Categories Of Mortgage Notes
Notes can be secured or unsecured. An unsecured note doesn’t have any collateral, which presents more risk to investors. On the other hand, a secured note is backed by the borrower’s mortgage or other assets. For this reason, mortgage notes make for an excellent real estate investment.
However, mortgage notes also come with risks. For instance, the property may go to inheritance because the borrower passed away or the loan has been fully repaid, which means repayments stop. As an investor, make sure to take due diligence to evaluate mortgage notes by assessing mortgage loan performance. Differentiating performing vs non performing notes can help you decide on the best mortgage notes to invest in.
- Non Performing Mortgage Notes: These real estate notes are 90 days or more past due. While these notes are riskier than performing notes, banks or note sellers usually offer huge discounts for non performing notes. Risk-takers generally know different strategies to make money out of non performing notes, such as exercising their power to foreclose the property and take possession of it. Some investors create flexible payment terms for delinquent borrowers so they can repay their debt (while the investor earns higher returns).
- Performing Mortgage Notes: These notes are more secure than non performing or underperforming notes because notes are regularly paid on time following the loan terms. Buying performing notes is also called ‘clipping coupons,’ in which the investor earns modest returns, paid at regular intervals.
3. Buying Mortgage Notes Considerations
You can make good money in real estate even without managing a property, made possible with real estate investment trusts or REITs and mortgage notes. Mortgage loans may include residential or commercial loans. Residential mortgage loans include single-family residences and multifamily homes. On the other hand, commercial mortgage loans include offices, warehouses, warehouses, amusement parks, and other buildings.
When buying mortgage notes, there are important things to consider, such as the following:
- Where To Buy Mortgage Notes: It’s important to ensure you’re getting a good deal buying mortgage notes by knowing the best places to buy one. You can invest in or buy mortgage notes via an individual investor (flipper) or bank.
- Vet The Borrower: Check the borrower’s income, payment history, and credit history to determine if the borrower can continue making payments.
- Check The Loan Details: Check how much money was borrowed, its interest rate, duration repayment, and terms when the borrower defaults on their payments.
4. Mortgage Notes And Self-Directed IRA
It’s possible to arrange the mortgage note’s terms to allow payments to go back into your investment retirement account (IRA). Hold mortgage notes in your self-directed IRA without worrying about vacancies and maintenance costs. If the borrower defaults on payment, your IRA can foreclose the property, and the property title will be transferred to your name.
Real estate notes in your IRA receive consistent income on a tax-free or tax-deferred basis. For traditional IRAs, you’ll only have to pay taxes when you withdraw your earnings. On the other hand, Roth IRA holds your earnings for a specific period (at least five years), and you can withdraw your earnings tax-free.
Generate good passive income by buying mortgage notes. If you prefer a more secure investment, choose performing notes. For risk-takers who know different strategies, non performing notes are recommended to obtain huge discounts on the prices. Also, brush up on your knowledge of the most essential details before buying mortgage loans to ensure a steady flow of passive income or profitable returns.