Mortgage can provide security to the lender for increased confidence in approving a borrower’s loan application. In short, one can use a real estate property or mortgage as collateral to borrow money from banks and other financial institutions, which will be used to buy a property or refinance a mortgage. Investors buy and sell notes because the interest rates are generally lower than traditional real estate transactions.  

Before you buy and sell real estate notes, it’s a good idea to understand their benefits to investors, how they work, and the consequences of missing loan payments for borrowers. Read this guide to understand real estate notes better.  

What Are Real Estate Notes?

When a real estate or mortgage is used as loan collateral, it’s called a real estate note, mortgage note, or promissory note. A real estate note is a contract or debt agreement between the lender and the borrower, and which contains the loan’s terms and conditions. Here are the findings that show how investors and borrowers can take advantage of real estate notes.

Content Of Real Estate Notes

Real estate notes contain the borrower’s name, property address, and mortgage loan terms, like a five-year adjustable rate mortgage (ARM). Also, a mortgage note includes the following:

• Interest rate
• Payments due date  
• Fees and penalties  

Benefits Of Real Estate Notes

Real estate notes can be beneficial for borrowers, lenders, and investors.  

• For Borrowers: Homeowners with default mortgage payments or foreclosure status can work with investors to find ways to refinance their loan, given a set of terms and conditions favourable for both parties.
• For Formal Lenders: Real estate note lenders make money through interests, financial penalties, and selling of foreclosed properties. Formal lenders are usually banks and other financial institutions.
• For Investors: Housing investors can offer loans to low- or middle-income families by agreeing to the terms of real estate notes. These are a highly suitable real estate investment that generates passive income. Once you buy a mortgage note, you automatically become the new lender of the borrower. You receive monthly payments when you buy mortgage notes, including both the interest and principal.

Where To Buy Real Estate Notes

While you can buy mortgage notes from banks and other financial institutions, it can be challenging for private individuals to do so. For this reason, many private investors use mortgage notes brokers to find the best real estate notes in both private and public deals.

Many private real estate holders usually decide to sell their notes before refinancing or balloon payment occurs. Because the real estate property backs up promissory notes, many investors purchase these securities and take on the risks.  

Mortgage notes reach the highest value when they’re due in just a few years. And, the price will depend on the principal balance, the property’s appraised value, the borrower’s credit history, and the number of previous mortgage payments. If you‘re a real estate note buyer, determine the mortgage notes’ value by identifying the number of future payments.

Real Estate Notes Versus Mortgage 

A mortgage is a loan that serves as collateral, allowing a borrower to finance a property. A real estate note or promissory note is a written and signed document that contains the borrower’s promise to repay the loan signed at closing.

Self-Directed IRAs And Real Estate Notes

Real estate note buyers can defer or avoid taxes by purchasing mortgage notes through their self-directed individual retirement account or IRA. Self-directed IRAs can be either Roth IRAs or traditional IRAs. Here are the details:

• Traditional IRA: The earnings and growth remain tax-deferred until the IRA owner starts withdrawing in retirement.
• Self-Directed Roth IRA: The IRA owner funds a Roth account with after-tax dollars, which means that taxes are already paid through the money the owner put into it. The owner holds the Roth IRA for a minimum of five years, and all withdrawals will be tax-free in retirement.

Default Payments

In general, the real estate note terms determine the borrower’s consequences when they default on payments. A financial penalty usually applies, such that the borrower can pay the missed payment at a higher amount.

Real estate notes fall into default after 90 days of missed loan payments, and this is the time when the foreclosure process begins. The remedies that lenders usually offer to avoid foreclosure include selling the real estate property in a short sale, taking the deed in exchange for foreclosure, or letting the owner sell the property while subjected to the existing loan. Lenders can also sell defaulted loans to other real estate investors to work out the best solution with the borrower.

If you buy real estate notes and the borrowers stop paying the mortgage, you can contact them. As the new lender, you can modify the mortgage loan terms or initiate foreclosure proceedings.

Risks

People can invest in real estate property without shelling out a huge sum of money through mortgage notes. However. like any other investments, real estate notes have potential risks, such as the following:  

• Litigation: One of the risk factors of investing in mortgage notes is litigation involving title or property problems, which means spending money on legal fees to fight for your interests.
• Borrower Default: Default borrower payments can lead to foreclosure, which can be time-consuming and expensive. When a real estate property is foreclosed, there’s no guarantee that the sale will help you recover the amount you paid in purchasing the real estate note.  
• Homebuyer’s Prepayment Options: Mortgages usually allow prepayments that most lenders can’t do much about. If the homeowner pays off their mortgage or comes into an inheritance (death of the borrower), you’ll no longer receive the monthly payments that a mortgage note provides.

Conclusion

A real estate note is a document signed at closing, serving as a legally binding document containing how a borrower can pay a mortgage loan. Buying and selling promissory or real estate notes can be a good investment because interest rates are low. It’s one way to acquire properties without paying the property’s market price by exercising your foreclosure power as the lender for default payments.

Buying mortgage notes using your self-directed IRA is one way to grow your earnings tax-deferred to tax-free, depending on the IRA you have. However, there are also some risks involved that investors should know about, such as litigation due to title issues, borrower’s default, and homebuyer’s prepayment options.