A real estate note or mortgage note is similar to a promissory note which is a written promise or obligation to pay a specific amount, with interest, within a specific time frame. The mortgage, also known as the security instrument, pledges the property as collateral to ensure the performance on the obligation. This allows the note holder to sell the property and re-coop his investment in the event the payer does not pay as agreed.
Mortgages can be sold over and over many times. In fact, it is very common. Those of you that have ever owned a home, you may have experienced this when you are notified that your loan is being serviced by another lending institution. Your mortgage note was just sold to another bank. Typically the terms don’t change for the homeowner.
Let’s say a property sold for $100,000 and the buyer put down a $30,000 payment. The seller of the property carried back a note in the amount of $70,000.00
Let’s also assume they wrote the note at 7% interest. If so, the note would look like this…
360 payments of $465.71.
You have an opportunity to buy the note after five years have gone by (it could be any number of years, just picking a round number for this example).
That means there are 300 payments remaining.
The “Present Value” or current balance owed on the note would be $65,810.77
How your risk is managed: The value of the property is $100,000 (assuming the property value stayed the same for the sake of this example)
That means your investment to value is 65.8% or that there is $34,189.23 of “equity” in the property.
You are earning 7% on a non traditional investment backed by something traditional – real estate. IF the payer does not make payments, you have the same rights the bank has. You can foreclose and take the property back. You can then resell, create another note, or sell for cash.
IF you had to take the property back, what is the likelihood that you can sell a property worth $100,000 for something more than $65,810.77? Pretty good, right?
Of course, this is a simple example and there are certainly some other variables, but you get the idea.
With notes, you have the benefits and security backed by real estate – without the headaches!
Your monthly payment can be electronically deposited into your account on the 1st of every month so you literally don’t have to do a thing. It’s the ultimate hands-off investment.
When it comes to the pecking order of mortgages, the first (or senior mortgage) sits in the driver’s seat. Should the borrower default on the first, then any junior liens (such as second mortgages) are in serious trouble and can be completely wipes out. So, as far as investors are concerned, in today’s market, buying the first puts the investor in the best position possible.
Using the same example above (you bought loan 5 years after its creation) and the loan went the full term (the borrower didn’t refinance or pay it off early), you would make $73,437.04 in interest. If you bought it when it was first created, you would make $97,656.23.
Crazy right? You would make more in interest than the person originally borrowed! And it happens all of the time. Isn’t it time you started cashing in on it?
Legal Mumbo Jumbo: In case you were wondering, the loan transaction consists of two main documents: the mortgage (or deed of trust) and a promissory note. The mortgage (or deed of trust) is the document that pledges the property as security for the debt and permits a lender to foreclosure if you fail to make the monthly payments, whereas the promissory note is the IOU that contains the promise to repay the loan. The purpose of the mortgage (or deed of trust) is to provide security for the loan that is evidenced by a promissory note.