Buying mortgage notes can provide an investor with secure returns and without the hassles and risks of buying and flipping a fixer-upper, locating tenants for a rental condo, or unclogging toilets.

When most people think about mortgage notes, they think about industry giants such as Chase or Wells Fargo. According to the Mortgage Bankers Association estimates, these institutions will originate over $1.3 trillion in residential mortgages this year.

Fortunately, there is a “subset” of the mortgage market called private mortgages. It comes in several forms.

A common one is “Seller Financing” — this is when the seller agrees to lend his or her buyer all, or just a portion of the home’s purchase price. Often the principal and interest payments are structured to amortize over 30 years just like traditional loans, but they require a balloon payment. This means that the borrower must then remit the entire outstanding principal after five years.

The expectation is that the borrower will, during these five years, refinance into a conventional-type loan from an institutional lender. If the borrower is unable to pay the full amount after five years, the note holder can foreclose and take back the home.

These seller-financed loans are generally used by borrowers who are unable to qualify for conventional institutional financing. This may not necessarily be a reflection of the borrower’s creditworthiness. For example, under existing institutional guidelines, many self-employed borrowers with high incomes and top credit scores still do not qualify for many institutional conventional loans.

Retirees face similar hurdles. For these reasons, private mortgage loans generally carry a higher-than-market interest rate. It is this high-interest rate that makes them attractive to real estate investors. Private mortgages are also originated by private lenders who are willing to lend money to home buyers at above-market rates provided that the loan is secured by the borrower’s property as collateral. These investors will want to conduct due diligence not only on the borrower’s ability to repay but also on the property’s market value and condition, should the investor have to foreclose.

Private mortgage notes are ready to sell in a robust secondary market.

Although their higher-than-market interest rates make them attractive as buy and hold investments, private mortgage notes can be sold and thus converted into cash. The amount they sell for is based on the principal balance, the number of payments that have been made (referred to as “seasoning”), the number of remaining payments, the home’s appraised value and the borrower’s creditworthiness.

The concept of “time value of money” also controls how much you should be willing to pay for a private mortgage note. This concept dictates that receiving a dollar today is worth more than receiving a dollar in the future. Tools are available online that will calculate the present value of a future stream of income. With all things being equal, the seller of a private mortgage note cannot expect to sell their note for the outstanding principal balance of that note. It can be sold only for the discounted “present value”, of the sum of the future payments.

As an example, assume a seller sells his home for $500,000; requiring a 20 percent down payment of $100,000. The seller agrees to lend the buyer the remaining $400,000. He also agrees to amortize the loan over 30 years. More examples here.

The note bears interest at 5 percent annually. To “season” the note, the seller holds it for six months and receives six monthly payments of principal and interest. After the sixth payment, the outstanding principal balance of the note is $396,593.

Our Value then is based on this outstanding balance minus other factors, such as property condition, market interest rates, and the borrower’s creditworthiness. The final price a note buyer would be willing to pay may be adjusted accordingly.

Private Investors who recognize the value of this secured type of investing, and want to realize steady, high and well-secured returns of their investment dollars are invited to contact us for further information on the investment opportunities and returns we can offer.