Mortgage note investing has become an increasingly popular alternative investment option for investors seeking fixed income streams. A mortgage note is a legal document that serves as evidence of a loan used to purchase real estate, with the property itself serving as collateral. By purchasing existing mortgage notes from banks and mortgage companies, investors can earn interest income from the borrower’s monthly mortgage payments.
Investing in mortgage notes provides several potential benefits compared to other fixed income instruments. First, mortgage notes can generate relatively higher yields, from 5% to even 12%, depending on factors such as the type and risk level of the underlying mortgage loan. Second, mortgage notes are backed by collateral in the form of real estate, providing an added layer of security. Finally, mortgage notes deliver predictable, monthly cash flow in the form of interest payments from the underlying loans.
However, mortgage note investing also comes with risks that investors must consider. The main risk is default risk, where the borrower stops making payments on the underlying mortgage loan. Mortgage notes are not insured or guaranteed like some other investments, so the investor takes on full default risk. Prepayment risk also exists, where the borrower pays off the loan earlier than expected, leading to a loss of future interest payments for the note holder. Proper due diligence is required to assess risks for each potential mortgage note investment.
Mortgage notes provide stable, fixed-rate returns not correlated to markets
One of the primary advantages of mortgage note investing is the stable, fixed-rate returns these instruments can provide. The interest rate on an existing mortgage note is set at the time the original mortgage loan was made and does not change over time. This differs from variable-rate investments such as bonds or bank CDs, which fluctuate in value as interest rates rise and fall. Mortgage note investors can rely on receiving the same fixed monthly payment over the life of the investment, regardless of broader economic conditions.
Additionally, returns from mortgage notes have low correlation to returns from stocks and other financial markets. This makes them an excellent way to diversify a portfolio focused heavily on equities. While stock markets may experience sharp ups and downs, payments on performing mortgage notes continue uninterrupted. An allocation to mortgage notes can therefore help smooth out the volatility within an overall investment portfolio.
Mortgage notes can be purchased at a discount for higher yield potential
Mortgage notes are often available for purchase from banks and lenders at a discount to the remaining principal balance on the underlying mortgage loan. This occurs for notes that have been delinquent, where the borrower has missed some payments. By purchasing at a discount, the investor is able to earn yield based both on the interest rate of the note and the discount received on purchase.
For example, a mortgage note with a remaining principal balance of $100,000 but available for purchase at $80,000 would effectively provide yield on the $20,000 discount in addition to the contractual interest rate. Factoring in the discount, the yield on this mortgage note investment could reach 10-12% even if the original note rate was only 6 or 7%. Investors must weigh the risks associated with delinquent borrowers, but deeply discounted notes can provide opportunity for enhanced returns.
Mortgage notes can provide diversification for real estate investors
Investors already involved in real estate may find mortgage notes attractive for further diversifying their real estate holdings. Owning the paper on real estate in the form of mortgage notes can provide income streams similar to owning physical property, but without the responsibilities of being a landlord.
Mortgage note investments also avoid issues such as vacancies, maintenance costs and geographic concentration that can come with directly owning real estate rentals. Since physical property ownership is concentrated to select geographic markets, mortgage notes can effectively allow investors to lend on real estate across a much broader area. This geographic diversification reduces risk compared to relying solely on performance of local property markets.
Mortgage note investing also requires less capital compared to purchasing entire rental properties, opening up this type of real estate investment to those without access to large downpayments. By offering fixed returns uncorrelated to equities plus added diversification for real estate investors, mortgage notes as an asset class can potentially improve the risk-return profile of an investment portfolio.
In summary, mortgage note investing provides a way for investors to earn attractive yields along with monthly cash flow. However, conducting due diligence to assess risks and having a strategy to manage defaults is critical. For investors comfortable with being a lender and undertaking the required research, mortgage notes can be a rewarding alternative investment.