As you start your investment journey, there’s one thing you’re going to hear over and over again: “Diversify!” The concept is absolutely true, you don’t want to put all your financial eggs in the same basket. But diversification is more than just selecting different stocks – sometimes it means finding financial products that are out of the spotlight to balance risk. One of these such financial products are private mortgage notes.
What is a private mortgage note?
When most people hear the term “mortgage” they think of large financial institutions like Bank of America and Wells Fargo. However, each year thousands of Americans sign what’s called a “private mortgage note” or also called in some areas a “real estate note.”
In a private mortgage, the seller acts as a bank would in a traditional mortgage. The property acts as collateral against the loan they gave to the home buyer to purchase it: if the home buyer defaults on the loan, the lender becomes the owner of the real estate.
Just like Bank of America can sell someone’s mortgage to another bank, the note holder can sell the private mortgage note to a buyer. The buying company gives the note holder a lump sum of cash, and from then out the buying company sells the incoming payments to an investor for returns sometimes as high as 15 percent.
And you can be that investor.
Why invest in mortgage notes?
Investing in mortgage notes is a way to invest in real estate with less hands-on involvement than traditional ways.
Usually, real estate investing typical involves either flipping a piece of property or buying property with the intent to act as its landlord.
Both options have advantages and disadvantages. One advantage is that real estate is often considered a fairly secure investment, especially from a long term investment perspective. But many find the amount of work you have to invest in either repairs needed to flip homes or the hassle of managing tenants to be tedious.
However, with mortgage notes, the investment is secured by real estate, which acts as collateral. But since the borrower is a homeowner, they take care of the property and there’s no need to manage tenants.
With a mortgage note, you just pay an upfront investment of capital, and then you receive the future payments from the home owner.
Types of notes
Both traditional and private mortgage notes can be purchased by investors. Investors can buy either a portfolio of notes or single notes. From an investment perspective, there are two main types of notes that an investor can purchase: performing notes and non-performing notes.
Non-performing notes are mortgages where the homeowners has not been making regular payments. Also referred to as distressed notes, these notes are often much cheaper for an investor and come with higher risk and a higher opportunity for return.
Different investors take different stances on how to manage non-performing notes. Some will take underwater and behind non-performing notes and work with the homeowner to restructure the loan and then sit back and let the payments come in. Others will purchase the note and then foreclose and resell the property.
Performing notes are notes are notes where the homeowner, aka borrower, is making regular payments. These notes obviously tend to have a lower risk and thus a slightly smaller return. Performing notes can be a great source of continual income for those planning their retirement.
Regardless of which note sounds appealing, this investment opportunity is one that should not be ignored on your path to diversified investing.
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Currently, Catherine covers personal finance and the secondary annuity market for several publications including StructuredSettlements.com.
When she's not writing about other people's money, she can be found at the beach or climbing a mountain.
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