An Introduction to Real Estate Mortgage Note Investing

There are almost endless options in real estate investing. When considering alternative assets, it’s important to understand all your options. Real estate mortgage note investing can be an excellent way to build wealth and grow passive income. But it’s essential to understand the basics so you can begin to create a winning strategy.

The Basics of Mortgage Note Investing

The novice investor sees real estate as a simple agreement: Buy a property, get it in shape, then reap the profits it generates.

More seasoned investors know there’s a lot more to it — like the part where a rental property owner has to do actual work. Or at least accept the legal responsibility of being a landlord or property manager.

Some real estate investors can handle being landlords, are good at it, and may even enjoy the work it involves. Others, not so much.

Thankfully, there’s a form of structured security that allows part-time investors and silent partners seeking passive income to benefit from a hot real estate market.

What Are Mortgage Note Real Estate Investments?

You know what a mortgage is: a loan that a buyer takes out to buy a property.

The mortgage note is essentially an IOU the borrower gives to the bank (or another type of lender) that issued the loan, outlining the interest rate, repayment terms, and the collateral secured against it.

Often, the lender will sell this promissory note to an outside party on the secondary market.

Sometimes, they do this to spur cash flow. Other times, they do it to cash out on loans that aren’t being repaid, so they cut their liability and avoid having to endure the foreclosure process.

Lenders sell these mortgage notes to real estate investors, hedge funds, or firms looking for a simple way to profit from real estate. The investor makes money from the paid interest or the sale of the property (or resale of the note itself).

mortgage note investing
Savvy investors are debating where the next opportunities will be in the mortgage market. A rise in delinquency rates might present interesting risk and reward potential in the months ahead.

In short, a mortgage note investor becomes the new “lender,” collecting monthly payments as the borrower makes them. The investor gets all of the payments for the principal and the interest. The original bank is no longer part of the picture.

Have you ever gotten a letter from a bank saying that you should now send your mortgage payments to another previously unknown third party? That’s because they sold your mortgage note.

Selling mortgage notes was one of the ways lenders crept their way out of the recession of 2007-2009. This method has gained popularity ever since and has matured into an immensely powerful alternative investment avenue.

Every day, more modern retail investors take advantage of the mortgage note market.

Why Investors Buy Mortgage Notes

The most obvious appeal of buying a mortgage note is the income it brings.

Mortgage notes are solid vehicles of passive income. They can be a great way to gain exposure to real estate investments and build wealth. Real estate mortgage notes offer several unique investment attributes for those trying to shore up their portfolio and retirement funds.

Many investors turn to mortgage notes to replace the income lost during an era of historically low-interest rates.

Investors find mortgage notes especially alluring because they’re secured against actual, physical real estate.

They’re often available at a significant discount to the remaining balance of the loan, especially when the note is “distressed” or facing potential foreclosure (though such notes are risky — we’ll cover that in a bit).

Where and How Investors Buy Mortgage Notes

Investors buy real estate notes in a few ways. They can get them directly from the bank, through their broker, or from other investors or private individuals. A few online sites offer them as well.

Some investors simply create mortgage note investments by offering private loans to potential homebuyers.

As is the case with most investment instruments these days, you can also invest in mortgage note funds. For the rest of this post, we’ll focus on single mortgage notes.

Breaking Down the Mortgage Note

The standard mortgage note is a combination of two separate documents: a promissory note and a lien.

A promissory note is essentially the lending contract between the lender and borrower. It outlines the amount of the debt, the interest rate, and the terms and conditions of the loan.

The lien is what gives the mortgage note its potency. It’s the statement of collateral in the form of either a mortgage deed or a deed of trust (depending on the state where the property is located).

The lien agreement secures the mortgage note buyer’s investment against the property the lender owns.

The mortgage note holder has options to get their investment back if the lender defaults on the loan terms. They can require the borrower to pay off all of the balance or initiate foreclosure proceedings.

Neither of these options is exactly fun, but the lien confers the note holder the right to use them both.

Lien Positions

A quick but important note about liens. The lien attached to a mortgage note is a separate document and can be in either the first or second position.

A first-position lien is tied to the original mortgage the lender takes out — what they used to buy the property in the first place.

A second-position lien (known as a “junior loan”) is tied to a secondary debt the borrower incurs, usually in a second mortgage on the property.

You can buy a mortgage note in either lien position, but it’s important to know what that position is before you buy.

If the property is sold due to foreclosure or bankruptcy, trustees will always pay off first-position liens before repayments on second-position liens can even begin.

First-position notes are therefore safer, though not without risk.

Second-position notes are far riskier but possibly more profitable. That’s because they’re quite cheap and can deliver a massive return on investment, given that everything goes as planned. Or you could lose the entirety of your investment.

Learn all you can about the lien before you buy. It’s beneficial to learn how the borrower’s repayment plan is going — as well as what level of risk tolerance you’re willing to stomach.

Types of Mortgage Notes

The kinds of mortgage notes investors can buy into are as varied and multiple as the real estate market itself.

There are residential mortgage notes for single-family homes, multi-family buildings, and rental property. There are commercial notes for offices, warehouses, shopping malls, and retailers.

You can even get a real estate note on a vacant land purchase, though it’s nowhere nearly as romantic. A mortgage note can be secured or unsecured — either backed up by collateral or completely lien-free.

The most important classification for mortgage notes pertains to the state of the borrower’s repayment of the debt: “performing” or “non-performing.”

Performing vs. Non-Performing Mortgage Notes

A performing mortgage note is just what it sounds like. The debtor has a good history of making regular payments and continues to do so. It’s a relatively safe bet.

A non-performing mortgage note is often called a “distressed” note. In this case, the debtor is having some trouble paying back the private loan. If they haven’t made a payment in 90 days or longer, the note generally becomes a non-performing one.

Why would an investor buy a non-performing note? For one thing, it’s usually much cheaper than a performing note. And it typically comes with elevated interest rates.

That’s because the lender — the party selling the mortgage note — wants to bail out of the loan and take whatever they can get. Also, the lender is probably not too keen about starting the long, expensive, draining foreclosure process.

Non-performing mortgage note holders have a few options when it comes to dealing with the defaulting borrower.

They could forgive part of the borrower’s debt so they can get back on track. Or they could force foreclosure — which means they could eventually take ownership of the property themselves. Then they could resell it for a return on their original investment.

Therein lies the appeal of non-performing notes for more speculative investors. But to reiterate: they are very, very risky. And possibly painful in the case of a foreclosure.

Just know everything you can about the note before buying — scrutinize it, whether it’s a performing or non-performing note. Be especially diligent if it’s a non-performing one.

Advantages and Benefits of Mortgage Note Investing

Some of the benefits of mortgage note investing include:

Income Without Ownership

All a mortgage note holder does is get paid. There are no landlord duties, no property managers, no tenants to deal with, no property taxes, no scheduling repairs or maintenance — just rivers of sweet, sweet loan and interest payments flowing into their pocket.

How much depends on a few factors. But in many cases, the return rates on mortgage loans are far higher than what investors make from stock dividends or low-yield bonds. Not bad for passive income.

High Liquidity and Availability

Mortgage notes are surprisingly liquid financial instruments, widely available on the bustling secondary investment market.

Unlike many private investment opportunities, mortgage notes are widely available to the retail investor class. You don’t need to be an accredited investor, institutional investor, or fund manager. You can just be yourself.


Compared to the principal and interest of the loan, a mortgage note can be shockingly inexpensive. Several factors influence the cost, but it’s fair to say buyers can have most of them for between $20,000 and $50,000.

Shrewd investors can often have non-performing notes for a fraction of the outstanding loan amount.


The mortgage note is secured by real estate property, which is still a very safe investment vehicle.

Disadvantages and Risks of Mortgage Note Investing

The biggest risks and possible pitfalls of mortgage note investing include:

Risk of Losing Your Entire Investment

Not to fear-monger, but mortgage notes entail some risk, whether it’s a first- or second-position note, a performing or non-performing note.

But every investment strategy, from mutual funds to junk bonds, entails some risk. As always, know how much you’re willing to lose should the worst occur.

Chance of Non-performing Notes Sliding Into Default

Taking on a note from a borrower who’s not making payments anymore is fraught with peril. If the borrower ultimately defaults, that can hurt the investor’s cash flow.

Compliance and Legal Issues

The mortgage note industry is subject to many of the regulations lenders must face, including the Fair Debt Collections Practices Act and others.

Mortgage note buyers must also be aware they may have to trudge through a legal labyrinth if bankruptcies or foreclosures happen.

Before You Take On a Mortgage Loan Note

If you’re ready to take the plunge in mortgage note investing, take a few important steps before buying in.

Have an Objective

This stipulation is boilerplate advice for every enterprise, especially real estate investments, and it certainly applies to mortgage notes. Assess your risk tolerance and have a plan in place before you call the bank or broker.

Conduct Due Diligence on the Borrower

You’ll have easy access to the borrower’s repayment history on the mortgage loan in the note. It’s best to get that information from the last two to three years of the mortgage.

If you can obtain information on the borrower’s income and credit history — admittedly, not always easy — that would be even more helpful.

Know All the Terms of the Mortgage Loan

Drill down on all of the ins and outs of the original loan: how much it was, what the interest rate is, whether it’s amortized, what the repayment timeline is, and what will happen if the borrower defaults.

Where To Buy and Invest in Mortgage Notes

There are numerous online services offering mortgage notes for sale. Paperstac, Garnaco, and Notes Direct are a few of the larger players. The advantage of using an online service can pay off with powerful screening tools for different types of notes, and compiled information from public records.

Another option is to invest in a fund that manages the buying and selling of notes, however, many of these funds are reserved for accredited investors only.

Another option is to purchase mortgage notes directly from a bank. Some of the largest potential returns are found in buying non-performing mortgage notes from a bank representative. Of course, this also carries the biggest potential risk, as well as lots of time and effort in researching the best deals.

There is, however, an online service that will identify lenders and banks who own non-performing notes. Bank Prospector outlines key data points for each note and provides contact information to the individual at the bank overseeing each note.

The Bottom Line on Mortgage Note Investing

This post just scratches the surface of what you need to know about mortgage loan notes. Like all real estate investments, myriad complexities and conditions govern this market and require your investigation.

Mortgage loan investing is also no way for real estate investors to get rich quickly — there’s no instant jackpot.

Mortgage note investing can be reliable sources of long-term, passive income for real estate investors, especially those well-versed in the field and familiar with property value.

Though it takes a lot of preparation and knowledge, all of the information you need to research is public. Although this is only for informational purposes and not investment advice, everything you need to be a successful note investor is at your fingertips. You don’t need an online master class or internet education hustle to learn what you need.

Earning the rewards of an income-generating rental property without having to answer angry renter emails? Yes, we’ll take that.