Buying Mortgage Notes as an Investment

Mortgage Note Buyers Can Make an Attractive Profit with Minor Effort

Mar 12, 2009

Private cash flow notes are a non-traditional investment which can turn a huge profit. If proper due diligence is performed prior to purchase, risk can be minimized.

Mortgage notes are loans which are created when a home is sold. Private mortgage notes are funded by a home seller rather than a bank or lending institution. They are also known as cash flow notes, seller financed notes, owner financed notes or seller carry-back notes.

Why Would a Private Mortgage Note be Created?

There are many reasons a home owner might elect to fund the transaction privately. Private transactions can be approved and funded much more quickly than a bank funded loan. The lending criteria may not be as strict as they might be if a bank were involved, which increases the buyer pool for the seller's home. If the home is non-conforming, it may be difficult to impossible for a buyer to get approval for a mortgage from a bank.

What Happens when a Private Mortgage is Funded?

When a private mortgage is funded, the mortgagee (the person buying the home) agrees to pay an agreed upon monthly payment to the mortgage note holder. The amount of the payment is determined by the terms of the loan, including the length of the loan and the interest rate.

Private mortgage notes are usually sold at a discount. This means that the mortgage note buyer will pay a discounted rate for the loan to the current mortgage note holder and, in turn, will then receive all future payments made on the loan by the mortgagee.

Privately held mortgage notes are sold at a discount because of the time value of money.This means that the value of the mortgage will decrease with time because of factors such as inflation. Think of it like this: If someone were to offer to give you either a $10 bill or a $20 bill, you would likely choose the $20 bill. But what if you could have the $10 today but had to wait 5 years to get the $20. Which would you choose now? Most of us would choose the $10 bill today because we realize that $10 today is worth more than the promise of $20 five years from now. This is the time value of money.

There are many answers to this question. The note holder may need a large sum of money immediately for purchasing another home, buying a car, sending a child to college or to start a business. Whatever the reason a large lump sum of money may be more valuable to the note holder than smaller amounts received monthly. In addition, the note holder may not want to worry about whether the mortgagee might default on the loan or just may not want to deal with servicing the loan.

How Does a Mortgage Note Buyer Know whether the Note is a Good Investment?

To determine the value of a mortgage note, the risk involved with the note must be evaluated. The higher the risk involved with the mortgage note, the larger the discount taken will be.

Consider the following criteria for evaluating the risk involved with the mortgage note:

Individual mortgage note buyers will need to determine their own standards for assessing the amount of the discount offered on the mortgage note and the amount of risk they are willing to accept as in any investment.

The copyright of the article Buying Mortgage Notes as an Investment in Funds Investing is owned by Lorie Huston. Permission to republish Buying Mortgage Notes as an Investment in print or online must be granted by the author in writing.