What is a Mortgage Note?
A mortgage or promissory note is a written agreement between two parties which states that one party is liable to pay a specified amount to another party on a specified date, in a specified method or on any other terms agreed upon by the borrower and lender.
The Mortgage, Deed of Trust, or Contract for Deed evidences the fact that the lender has a lien on a property based on the loan he has made and has the right to collect payments in the amount of, and according to, the terms contained in the note. It further imposes a requirement on the borrower to repay the debt. A mortgage note describes in detail the penalties if the borrower fails to repay the loan according to the agreed upon terms.
In foreclosure proceedings, the court requires the lender to produce the Mortgage Note to prove the lenders ownership of the debt and terms under which the loan was made.
Types of Mortgage Notes
There are different types of mortgage notes. The type is determined by the terms written in the note. The types of notes are detailed below:
1. Fixed-Rate Mortgage Note: The interest rate and monthly payment amount are fixed for the entire loan term.
2. Graduated Payment Mortgage Note: The initial interest rate is fixed for a period of usually several years and adjusts thereafter.
3. Adjustable-Rate Mortgage Note: The interest rate and monthly payment amount are based on a short-term index and fluctuate accordingly. Some indexes such as LIBOR are reset monthly, quarterly, or annually. These are also known as “ARMs.”
4. Balloon Payment Mortgage Note: The amortization schedule of the loan is beyond the final payment date. Thus, the remaining balance or a “Balloon” payment is required at the loans’ maturity date. An example of this type of loan has a 10-year term but amortizes over a 30-year period.
5. Interest-Only Mortgage Note: The loans principal is not amortized over the terms. The borrower only makes interest payments and the principal is not amortized. The loans entire principal amount is paid at maturity.
6. Negative Amortization Mortgage Note: When the loan payment is less than the interest charged. This creates deferred interest which is added to the principal balance of the loan. In this case, the principal amount owed increases over the term costing the consumer more in the long run.
Of all the types of loans discussed here, Fixed Rate notes make the safest investments. They avoid rate adjustments or demands for total repayment during the amortization period which increases the likelihood that the borrower will be unable to make his/her payments. Adjustable Rate, Balloon Payment and Negative Amortizing loans that were irresponsibly made were a large cause of the country’s last recession.
Are Mortgage Notes Profitable?
Yes. Investments in Mortgage Notes have several key factors that make them better investments than many alternatives.
- Notes provide returns that are equal to or above the stock market’s 20-year average. Since we only buy seasoned first trust notes with low loan to values much of the risk is offset by the secured real estate.
- Notes are not subject to swings in the market. If a market softens rents and prices may drop but loan payments remain stable. Mortgage notes offer the lender the flexibility to mitigate losses by enabling them to work with the borrower to arrange a payment schedule that works for both parties. If necessary, they can foreclose and redeem all or a portion of the value of their investment.
- Notes do not require daily management. Many investors owning real estate have to deal with the “3 T’s”, tenants, taxes and toilets. Notes are serviced by professional servicing companies A lender’s only responsibility is to determine if the monthly payments are made.
How to Buy Mortgage Notes
The process of buying mortgage notes consists of four steps:
Where to Find Real Estate Mortgage Notes for Sale
Buying mortgage notes can be financially rewarding but high-quality notes can also be difficult to find. In all cases, buyers are cautioned to underwrite their notes carefully. There are many pitfalls that are easy to overlook. There are five places to find mortgage notes for sale:
A. Private Note Holders: Some private individuals create notes to sell or want to liquidate their inventory for other investments.
B. Banks and Credit Unions: Banks and Credit Unions can be a good source for non-performing loans. They typically don’t sell performing notes. If they do the margins are extremely thin.
C. Private Equity or Hedge Funds: They buy mortgage notes in large numbers from banks and re-sell them to interested parties. They typically will only sell in bulk.
D. Special servicers: Occasionally investors will tell their servicer that they would like to sell some of their notes. Servicers will typically call existing clients to determine their interest.
F. Note Exchanges: There are several note exchanges online that sell mortgage notes. An online search is a good place to start.
How to Evaluate Mortgage Notes
There are six basic criteria for evaluating notes.
- The Borrower- Since the borrower makes the payments on your note you need to understand his/her credit rating, what type of work he/she does and other factors concerning their ability and willingness to repay the debt.
- The Collateral- What is the quality of the home? Is it well maintained? What is the area’s crime rating? Is it in a city or miles from any other homes?
- The Borrower’s Equity – How much equity does the borrower have in the home? What was his down payment? How much has the paid down on the loan? Has the property appreciate in value?
- The Terms of the Loan – Generally speaking shorter term loans are more valuable than longer term because your investment is returned quicker. Does the loan have a balloon payment? Do the payments change at any point? All of these factors can affect the borrower’s ability to repay the loan.
- The Payment History – How consistent has the borrower been making his payments? Is he consistent on time, late, early?
- The Paperwork– Many transactions have been ruined by faulty documentation. Investors have to make sure they have a clean chain of title, that the terms of the documents are consistent and valid in addition to many more factors.
How to Make Offers on Mortgage Notes
If you are interested in buying mortgage notes, you may make offers to sellers in the following ways:
- Indicative Bid: Most sellers, whether they are exchanges or individuals, require the submission of indicative bids based on preliminary information. If the bid is accepted the seller will provide additional information so the note can be further underwritten.
- Direct Offer: Several exchanges or banks post acceptable prices and buyers are provided a near complete collateral file for underwriting at the outset.
Closing the Deal
Once a price is agreed upon the seller will prepare and Purchase and Sale Agreement detailing the terms of the sale. The purchase/sale process requires that the mortgage is assigned to the buyer, an allonge is prepared, the deed is recorded in addition to other documentation. A servicer must be selected, and arrangements made to service the notes. Once the documents are in order the transaction can be funded either through escrow or directly with the seller.
Buying mortgage notes can be lucrative and enjoyable if they are properly underwritten. However, there are many pitfalls for beginners. Many investors buy higher yield and riskier 2nd liens or defaulted notes. We only buy well-seasoned, 1st lien notes with good payment histories that are suitable for retirement accounts and Self Directed IRA accounts. It helps to have a good investor/broker who is an expert in the field to guide you through the process. Some investor/brokers sell “partials” which are the first payments made on a note for a determined period of time. An example of this is when an investor/broker sells the first 10 years of payments on a 25-year note. This offers the buyer a high degree of security since the investor/broker doesn’t get paid until after the buyer’s investment is returned. Thus, he has a long-term interest in the note’s quality.
Feel free to contact us at firstname.lastname@example.org or call 800-502-5212 for more information and advice on buying mortgage notes. We take the guesswork out of the process for you. Your success is our top priority.