Real Estate Note Investing: Buy Debt, Earn Interest

While most real estate investors focus on owning physical properties, savvy investors are discovering the lucrative world of note investing—buying and profiting from mortgage debt rather than buildings. This alternative strategy offers passive income, reduced management headaches, and attractive returns, often in the 8-15% range or higher.

What Is Real Estate Note Investing?

When someone buys property with financing, they sign a promissory note agreeing to repay the loan. This note is a negotiable instrument—meaning it can be bought and sold just like any other asset.

As a note investor, you're purchasing the debt, not the property. You become the lender, entitled to receive the borrower's monthly payments, including [principal and interest](/blog/amortization-schedule-guide). If the borrower defaults, you have the right to foreclose and take ownership of the underlying property.

Types of Real Estate Notes

Performing Notes

These are current, active loans where the borrower makes regular, on-time payments. They offer:

• Predictable passive income from monthly payments
• Lower risk since borrowers are paying as agreed
• Less management than rental properties
• Typical returns of 6-12%

Performing notes appeal to investors seeking stable, mailbox money without property management responsibilities.

Non-Performing Notes (NPNs)

These loans are in default—borrowers have stopped making payments (typically 90+ days delinquent). While riskier, they offer:

• Steep discounts (often 40-60% of unpaid balance)
• Higher potential returns (15-30%+ if resolved successfully)
• Multiple exit strategies (loan modification, short sale, foreclosure, deed-in-lieu)
• Opportunity to help distressed homeowners find solutions

NPNs require more active management and expertise but can generate exceptional returns for experienced investors.

First Position vs. Second Position Notes

First position notes (first liens) have priority—if foreclosure occurs, they're paid before other debts. This provides:

• Lower risk and better security
• Higher prices (smaller discounts)
• Easier to value and sell

Second position notes (second liens or HELOCs) are subordinate to first mortgages:

• Higher risk if property value is insufficient
• Steeper discounts at purchase
• Potential for higher returns if successful
• Require careful equity analysis

Why Invest in Real Estate Notes?

True Passive Income

Unlike rental properties, note investing provides income without:

• Tenant management or midnight emergency calls
• Property maintenance and repairs
• Vacancy concerns or marketing
• Property taxes and insurance (borrower's responsibility)
• HOA fees or utilities

You simply collect monthly payments and occasionally review account statements.

Lower Entry Capital

You can start note investing with smaller amounts than traditional real estate:

• Partial notes (buying portions of loans)
• Seller-financed notes from individual sellers
• Heavily discounted non-performing notes
• Pooled note funds with $25,000-$50,000 minimums

Diversification Benefits

Notes provide diversification within real estate and across asset classes:

• Different risk profile than property ownership
• Uncorrelated with stock market volatility
• Collateralized by real property
• Multiple geographic markets simultaneously
• Various note types and positions

Secured by Real Estate

Unlike unsecured debt, your note investment is backed by a physical property. If the borrower defaults, you can foreclose and take ownership—providing downside protection not available with other debt investments.

Higher Returns Than Traditional Fixed Income

In a low-interest environment, note investing offers substantially better yields than:

• Bank CDs (1-3%)
• Investment-grade bonds (3-5%)
• Money market funds (1-2%)

Performing notes typically yield 8-12%, while successfully resolved non-performing notes can return 20-30%+ annually.

How to Find Real Estate Notes

Note Marketplaces and Brokers

Specialized platforms connect note buyers with sellers:

• Paperstac: The largest online note marketplace
• Note Listing Service: Subscription-based note listings
• FCI Exchange: Platform for performing and non-performing notes
• Note brokers: Intermediaries who source deals for buyers

Directly from Banks and Lenders

Financial institutions periodically sell non-performing loans to clean up their balance sheets:

• Regional and community banks
• Credit unions
• Hard money lenders
• [Portfolio lenders](/blog/portfolio-lending-guide)

Building relationships and getting on their contact lists can provide deal flow, though minimum purchases are often $1 million+ for institutional tape sales.

Note Funds and Crowdfunding

For smaller investors, pooled vehicles offer access:

• Private note funds (typically $50,000+ minimum)
• [Real estate crowdfunding](/blog/passive-real-estate-investing-guide) platforms with note investments
• [Self-directed IRA](/blog/dscr-loan-self-directed-ira) note funds

Seller-Financed Notes

When property sellers carry financing for buyers, they create notes that can be purchased:

• Identify seller-financed transactions through public records
• Contact sellers who may want to cash out early
• Offer discounted buyouts for lump-sum liquidity

Due Diligence: Evaluating Note Investments

The Note File Review

Every note purchase should include thorough examination of:

Promissory Note: The borrower's promise to repay, including amount, interest rate, payment schedule, and maturity date.

Mortgage or Deed of Trust: The security instrument that gives you foreclosure rights if the borrower defaults.

Assignment: Documentation transferring the note from seller to you, establishing your legal ownership.

Allonge: An attachment to the note formally endorsing it to you.

Title Policy: Insurance confirming clear chain of title and your lien position.

Payment History: Record of all payments made, showing performance track record.

[Property Valuation](/blog/cap-rate-explained-real-estate-investors)

Order a Broker Price Opinion (BPO) or appraisal to determine current market value. This is critical for:

• Calculating loan-to-value (LTV) ratio
• Assessing your security position
• Determining potential foreclosure recovery
• Pricing non-performing notes appropriately

Target LTV ratios:

• Performing notes: 80% LTV or lower
• Non-performing notes: 60% LTV or lower (allows cushion for foreclosure costs)

Borrower Research

Understanding the borrower's situation helps predict outcomes:

• Credit reports and scores
• Employment and income verification
• Occupancy status (owner-occupied vs. vacant)
• Bankruptcy history
• Communication willingness

For non-performing notes, occupied properties with employed borrowers who communicate are much more likely to be resolved successfully than vacant properties with unresponsive borrowers.

Title and Lien Search

Verify:

• Clear chain of title
• Your lien position (first or second)
• Other liens (tax liens, HOA liens, junior mortgages)
• Easements or encumbrances
• Proper recording of all documents

Legal and Regulatory Compliance

Ensure the note complies with:

• State and federal lending laws
• TILA and RESPA requirements
• Dodd-Frank regulations (for newer loans)
• State foreclosure procedures

Non-compliance can complicate or prevent foreclosure, destroying your investment thesis.

Strategies for Performing Notes

Buy and Hold for Yield

Purchase performing notes at a discount to par (face value) and collect monthly payments. Your yield comes from:

1. Discount at purchase: Buying a $100,000 note for $85,000 provides $15,000 in equity
2. Interest payments: Monthly interest from the borrower
3. Principal paydown: Gradual amortization increasing your equity

Example: You buy a $100,000 note at 8% interest with $900 monthly payments for $82,000.

• Immediate equity: $18,000
• Monthly cash flow: $900
• Annual cash-on-cash return: 13.2% ($10,800 annual / $82,000 invested)
• Total return increases as principal pays down

Sell at a Premium

After seasoning (establishing payment history), you can resell the note at a higher price:

• Buy discounted notes from motivated sellers
• Collect payments for 12-24 months, establishing performance
• Resell to institutional buyers or yield-seeking investors at a smaller discount

Partial Purchase

Rather than buying the entire note, purchase a portion of the payment stream:

• Lower capital requirement
• Reduced risk exposure
• Shorter investment horizon

Example: A $150,000 note with $1,200 monthly payments has 15 years remaining. You purchase the next 60 payments for $50,000, after which the seller regains full payment rights.

Strategies for Non-Performing Notes

Loan Modification

Work with the borrower to create an affordable payment plan:

• Reduce interest rate
• Extend loan term
• Capitalize arrears into new balance
• Offer principal forgiveness (in extreme cases)

Goal: Convert the non-performing note to a performing note, then hold for cash flow or resell at a profit.

Example: You buy a $120,000 non-performing note for $50,000. Property value is $140,000, but the borrower lost their job and fell 18 months behind. You modify the loan to $130,000 at 5% interest with new payment schedule. The borrower resumes payments, and you now hold a performing note worth $100,000+, creating $50,000+ profit.

Deed-in-Lieu of Foreclosure

Negotiate with the borrower to voluntarily transfer the property deed to you, avoiding costly foreclosure:

• Faster than foreclosure
• Lower legal costs
• Less adversarial process
• Cleaner title transfer

You then sell the property, keep it as a rental, or renovate and flip.

Short Sale

If the borrower wants to avoid foreclosure, facilitate a short sale:

• Allow the borrower to sell for less than owed
• You agree to accept the sale proceeds as payment in full
• Borrower avoids foreclosure on their credit
• You recover your investment faster than foreclosure

Foreclosure and REO

If other strategies fail, foreclose and take ownership (Real Estate Owned):

• Hire foreclosure attorney
• Follow state-specific legal procedures
• Take title to the property
• Sell, rent, or renovate the property

Foreclosure timelines vary dramatically: 3-6 months in some states, 2+ years in others like New York or New Jersey.

Calculating Returns and Pricing Notes

Yield to Maturity (YTM)

The annualized return if you hold the note until fully paid off, accounting for:

• Purchase price discount
• Interest payments received
• Principal amortization
• Remaining loan term

Example: A $100,000 note at 7% interest with 15 years remaining and $900 monthly payments is offered at $85,000. The YTM is approximately 9.2%.

Cash-on-Cash Return

Simple annual return based on cash flow:

Annual payments received ÷ Purchase price

This doesn't account for equity buildup or payoff, but provides a quick comparison metric.

Pricing Non-Performing Notes

Use conservative formulas based on likely outcomes:

Basic formula: Property Value × 60-70% = Maximum bid

Example: Property worth $150,000 with a $120,000 non-performing note.

• Maximum bid: $150,000 × 65% = $97,500
• This allows $32,500 cushion ($150,000 - $97,500 - $20,000 foreclosure costs = $32,500 profit)

Adjust based on:

• Occupancy status (occupied = higher)
• Borrower communication (responsive = higher)
• Property condition (good = higher)
• Local foreclosure timeline (faster = higher)

Building a Note Portfolio

Diversification Strategies

Spread risk across:

• Geographic markets: Different states and cities
• Property types: SFR, multi-family, commercial
• Note positions: First and second liens
• Performance status: Mix of performing and non-performing
• Loan sizes: Various balances

Recommended starting allocation:

• 70-80% performing notes (stable income)
• 20-30% non-performing notes (higher returns, active management)

Scaling Your Note Business

Phase 1 (0-5 notes): Learn fundamentals, build systems, establish team (attorney, servicing company, title agent).

Phase 2 (5-20 notes): Develop specialized expertise (geographic area or note type), hire virtual assistants for administrative tasks.

Phase 3 (20+ notes): Consider hiring staff, potentially raising capital from investors, or creating a fund structure.

Working with Note Servicers

Unless managing just 1-2 notes, hire professional servicing:

Servicers handle:

• Payment collection
• Borrower communication
• Escrow management (taxes and insurance)
• Default notifications
• Monthly statements

Costs: Typically $15-30/month per performing note, $30-50/month for non-performing.

Recommended servicers: FCI, Madison Management, VALON.

Legal and Regulatory Considerations

Dodd-Frank Act Implications

The Dodd-Frank Wall Street Reform Act created regulations affecting note investors:

• Owner-occupied properties: Stricter rules on loan modifications and foreclosures
• Ability-to-repay requirements: Modifications must verify borrower capacity
• Licensing: Some states require debt collector or loan servicer licenses

Exemptions exist for investors holding fewer than a certain number of loans annually, but regulations are complex—consult a specialized attorney.

State Foreclosure Laws

Foreclosure procedures vary dramatically by state:

Judicial states (e.g., Florida, New York, New Jersey): Require court process, taking 1-3+ years.

Non-judicial states (e.g., California, Texas, Arizona): Allow trustee foreclosure without court, taking 3-6 months.

Understanding your state's procedures is essential for pricing and strategy.

Debt Collection Compliance

If you contact borrowers about defaulted notes, you must comply with:

• Fair Debt Collection Practices Act (FDCPA)
• Telephone Consumer Protection Act (TCPA)
• State debt collection laws

Most investors hire servicers or attorneys to handle borrower contact, ensuring compliance.

Common Pitfalls to Avoid

Insufficient Due Diligence

Never skip thorough file review, title search, and property valuation. Missing issues can destroy your investment:

• Forged documents
• Broken chain of title
• Senior liens you weren't aware of
• Uninhabitable property conditions
• Borrower bankruptcy

Overpaying for Non-Performers

Optimism bias leads many new investors to overpay, assuming they'll easily modify or resell. Use conservative valuations and always have multiple exit strategies.

Ignoring Foreclosure Timelines

A note in New York (3+ year foreclosure) is worth far less than an identical note in Texas (6-month foreclosure). Factor jurisdiction into pricing.

Poor Servicer Selection

Cheap servicers may provide poor communication, slow payment processing, and inadequate reporting. Pay for quality—your servicer is your operational backbone.

Buying Without a Team

Successful note investing requires:

• [Real estate attorney](/blog/how-to-build-real-estate-team) (preferably with foreclosure experience)
• Title company or abstractor
• Note broker or mentor
• Servicer
• Tax professional

Attempting to do everything yourself courts disaster.

Neglecting IRS Reporting

Note sales, modifications, foreclosures, and even non-performing note purchases have tax implications. Work with a CPA who understands note investing to avoid surprises.

Tax Considerations

Interest Income

Interest payments from performing notes are taxed as ordinary income at your marginal rate.

Capital Gains

When you sell a note for more than your purchase price, the profit is typically capital gain:

• Short-term (held <1 year): Taxed as ordinary income
• Long-term (held >1 year): Preferential capital gains rates (0%, 15%, or 20%)

Foreclosure and REO

If you foreclose and take ownership:

• Your cost basis becomes your note purchase price plus foreclosure costs
• Subsequent sale is treated as real property sale for tax purposes

Self-Directed IRA Benefits

Many investors hold notes in self-directed IRAs:

• Tax-deferred or tax-free growth (traditional or Roth)
• Interest and capital gains grow tax-sheltered
• Required minimum distributions apply (traditional IRAs)

Prohibited transaction rules are complex—work with a specialized custodian and CPA.

Technology and Tools for Note Investors

Note Analysis Software

• NoteSchool Note Calculator: Analyzes yield, pricing, and returns
• Excel templates: Custom spreadsheets for cash flow modeling
• Paperstac calculators: Built-in analysis tools on the marketplace

Due Diligence Resources

• Title search services: NetronOnline, TitleFox
• BPO providers: Clear Capital, ServiceLink
• Public records: PropertyShark, Foreclosure.com
• Credit reports: Experian, TransUnion, Equifax

Document Management

• Cloud storage: Google Drive, Dropbox for secure file organization
• CRM systems: Track borrower communication and deal pipeline
• E-signature: DocuSign, HelloSign for remote document execution

Getting Started: Action Plan

Step 1: Education (1-3 months)

• Read recommended books: "The Complete Guide to Buying and Selling Performing Notes" by Dawn Rickabaugh, "Paper Money" by Dalbey
• Join note investing forums and Facebook groups
• Attend virtual or in-person note investing workshops
• Study state foreclosure laws in your target markets

Step 2: Build Your Team (1-2 months)

• Interview and select a real estate attorney with foreclosure experience
• Research note servicers and establish accounts
• Connect with note brokers on platforms like Paperstac
• Find a CPA familiar with note investing taxation

Step 3: Analyze Deals (Ongoing)

• Review 50-100 note listings to calibrate pricing and recognize good deals
• Run analysis on various scenarios (performing, non-performing, different LTVs)
• Develop your own underwriting criteria and spreadsheets

Step 4: Start Small (First 6 months)

• Purchase 1-2 small performing notes to learn servicing and processes
• Consider starting with partial notes to reduce capital requirements
• Focus on first-position notes in non-judicial foreclosure states
• Avoid non-performing notes until you've mastered fundamentals

Step 5: Scale and Specialize (6+ months)

• Gradually add notes to build a diversified portfolio
• Develop expertise in specific niches (geography, property type, note type)
• Consider non-performing notes once you have team and systems in place
• Explore raising capital from partners or creating a fund structure

Frequently Asked Questions

How much money do I need to start note investing?

You can start with as little as $10,000-$25,000 for partial notes or heavily discounted non-performers. However, $50,000-$100,000 provides more flexibility to diversify and purchase quality full notes. Note funds often have $25,000-$50,000 minimums.

Is note investing passive income?

Performing notes are largely passive—servicers handle payment collection and most administrative tasks. Non-performing notes require active management (borrower negotiation, legal processes, property disposition), similar to or exceeding [rental property management](/blog/how-to-raise-rent).

What returns can I expect?

Performing notes typically yield 8-12% annually. Successfully resolved non-performing notes can return 15-30%+ (sometimes much higher). However, NPN returns vary widely based on your expertise, with losses possible on deals that don't work out.

Can I invest in notes with my IRA?

Yes, self-directed IRAs can hold real estate notes, providing tax-advantaged growth. You'll need a self-directed IRA custodian that allows alternative investments. All income flows back to the IRA, and you cannot personally benefit from the investment.

What happens if the borrower files bankruptcy?

Bankruptcy complicates matters but doesn't eliminate your security interest. Chapter 7 may discharge the borrower's personal liability but not the lien on the property. Chapter 13 may modify loan terms. You'll need an experienced attorney to navigate bankruptcy proceedings.

How do I handle property taxes on foreclosed properties?

Once you take ownership through foreclosure, you're responsible for property taxes going forward. Unpaid back taxes may be senior liens you must satisfy. Always verify tax status during due diligence and factor into your pricing.

Where can I find notes to buy?

Online marketplaces (Paperstac, FCI Exchange), note brokers, banks and credit unions, hedge funds selling notes, and directly from property sellers who carried financing. Networking at note investing conferences and online communities also generates deal flow.

Do I need a real estate license to invest in notes?

No, purchasing notes as a principal (for your own account) doesn't require licensing. However, brokering notes for others or operating as a loan originator might require licensing depending on your state.

What's the difference between a note and a mortgage?

The note is the borrower's promise to repay the debt, containing the payment terms. The mortgage (or deed of trust) is the security instrument that creates a lien on the property and gives you foreclosure rights if the note isn't paid.

Are note investments secured by FDIC insurance?

No, private note investments have no FDIC or government insurance. Your security is the underlying property collateral. This is why thorough due diligence, conservative LTV ratios, and proper documentation are essential.

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Real estate note investing offers a compelling alternative to traditional property ownership—providing passive income, attractive returns, and portfolio diversification with less management than rentals. Start with education and small performing notes, build your team and systems, then gradually expand into more sophisticated strategies. With disciplined due diligence and patient capital, note investing can become a cornerstone of your wealth-building strategy.

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