Note Investing
Note investing is the practice of purchasing existing promissory notes (mortgage loans) secured by real estate, typically at a discount from the unpaid principal balance. Instead of buying a property directly, the note investor buys the debt obligation -- becoming the lender and receiving the borrower's monthly mortgage payments. The note is backed by a deed of trust or mortgage lien on the property, giving the note holder the right to foreclose if the borrower defaults.
Performing vs non-performing notes
Performing notes are loans where the borrower is current on payments. These are purchased for passive income -- the investor collects monthly payments at the note's interest rate. Performing notes typically sell for 70-90% of the unpaid balance. A $100,000 note purchased at 80 cents on the dollar ($80,000) paying 6% interest generates $600/month in income on an $80,000 investment, yielding an effective return well above 6%.
Non-performing notes (NPNs) are loans where the borrower has stopped paying. NPNs sell at steep discounts -- often 30-60 cents on the dollar -- because the buyer assumes the risk and cost of workout. Resolution strategies include loan modification (restructuring terms so the borrower resumes paying), short sale (the borrower sells the property for less than owed), deed-in-lieu (the borrower transfers the property to avoid foreclosure), or completing the foreclosure to take ownership of the property.
How note investing works
Notes are sourced from banks liquidating loan portfolios, hedge funds, government agencies (HUD, Fannie Mae), online note exchanges, and private sellers. Due diligence on a note purchase includes verifying the note terms (interest rate, remaining balance, payment schedule), checking the borrower's payment history, confirming the lien position (first lien vs second lien -- first liens have priority in foreclosure), evaluating the underlying property value relative to the loan balance, and reviewing the complete collateral file (original signed note, recorded mortgage or deed of trust, title policy, and chain of assignments).
Self-directed IRAs and Solo 401(k)s are popular vehicles for note investing because the interest income and capital gains are tax-deferred or tax-free (in the case of Roth accounts). Note investing is also attractive because it can be done remotely -- you do not need to visit properties, manage tenants, or coordinate renovations. The collateral (the property) secures your investment, but your relationship is with the paper, not the building.
Why it matters for wholesalers
Note investing intersects with wholesaling in several ways. Some of your buyers may be note investors looking for properties to acquire through NPN workouts -- understanding their perspective helps you identify deals they want. Properties in pre-foreclosure often have notes that could be purchased as an alternative acquisition strategy. Additionally, seller-financed deals create new notes that can later be sold to note investors, giving you additional exit strategy options when structuring creative deals.