Buying Mortgage Notes

Mortgage notes are loans, which are created when a home is sold. A home seller rather than a bank or lending institution funds private mortgage notes. The seller has some risks of making sure that the buyer makes their payments on time. If the buyer defaults, then the seller has the legal burden of collecting the debt. However, the benefits outweigh the risks because the seller gets a reasonable profit on the loan when the buyer pays the property off and the seller gets rid of the property.

Mortgage notes are also known as cash flow notes, seller financed notes, owner financed notes or seller carry-back notes. These notes can be purchased. Meaning if the property owner decides they want to receive a lump sum cash payment, they can sell the note to the investor or investment company and use the money for a vacation, college tuition, estate planning or just get rid of the risks of holding a mortgage note.

Why Would an Investor Want to Purchase a Private Mortgage Note?

The decision to invest in a private mortgage note is based upon the equity and value of the property being used as the collateral. It is fairly secure investment for the investor because the real estate secures the note. The main benefits to an investor of purchasing mortgage notes are as follows:

Mortgage notes are usually sold at a discount, the buyer paying a discounted rate for the loan to the current mortgage note holder and in turn receiving all future payments made on the loan by the mortgagee.

Determining the Value of a Mortgage

The higher the risk, the larger the discount taken will be. Note buyers will need to determine the amount of risk they are willing to accept with this investment:

• Examine the credit score for mortgage investors by looking at payment histories on the loan. Look at how does the borrower intend to pay back the loan.
• Determine the value of the property which serves as collateral. Typically 70% of the residential home value is the maximum loaned. Therefore, the investor knows that there is at least 30% equity in the property.
• Understand the terms of the loan (interest rate, length, etc.).
• Learn what down payment was made on the property.
• Understand the status of the loan (current? Default?). If the buyer is in default, what are the current market values of similar homes in the area? Will the investor be able to sell the home and still make a profit? (How much money is remaining to be paid on the loan balanced against the value of the property?)

Elements that Affect the Price of the Note

The following elements should be considered when purchasing a mortgage note:

• The amount of equity in the property. If the property has more than 30% equity, you have a cushion if the buyer defaults and you have to sell the home.
• The length of time (seasoning) that the borrower has been making payments. Does the borrower have a history of making their payments on time and for how long of period have they been current.
• The rate of interest on the note. Is it profitable enough to make a good rate of return on the investment?
• Amount of time left on the note (balloon period). Is there a large balloon payment payable at the end of the note term? Generally these types of loans are short term.
• Quality of credit of the borrower. What is the borrower's credit history and score?
• Size of the purchase price. Is there enough equity to justify the purchase price of the loan?

Mortgage notes are lucrative investments for investors because they pay a high rate of return on the investment. There are some risks involved. A Real Estate lawyer who specializes in Mortgages and mortgage note selling or buying can assist you to understand the complexities involved.