Hi, I’m Tim Fitzgerald, President of NoteInvestors.com. We’re the longest-running educational note-related website in existence, 23 years and counting now.
I believe you’re here because you want to learn about note investing, and I’m going to give you a crash course in exactly what it is and what’s involved in under 5 minutes– so, here we go!
Say you take out a mortgage loan to buy a home and are now making regular monthly payments to your bank.
The bank can hold the loan to term or, alternatively, the bank could decide to cash out of their position in the loan at some point and let someone else collect the rest of the payments over the remaining months and years.
To do that, they can sell off the note. The note is the legal document which spells out the original loan amount and terms under which you are paying, The note is an IOU which entitles the holder to receive the payments being made on it. The note is backed by a mortgage which names the property as collateral in the event of payor default.
So, the bank can generate immediate operating capital by selling off the rights to receive the monthly payments that remain on the note to another investor, usually at some kind of a discount off the face value of the total remaining balance. In exchange for their position as the note holder, the bank receives a cash lump sum from the investor, who then becomes the new note holder.
In selling the note for all cash, the bank recoups the bulk of the remaining balance of the loan now as a lump sum to be deployed elsewhere, no longer having to wait years and months to collect smaller individual payments.
As the future payments come in, the investor who buys the note will be earning a higher yield than the note is written for over the remaining months and years, because they invested less than the face value of the remaining (unpaid) principal balance.
“Buying at a discount” is tied to the “time value of money” principle– cash in hand today always being worth more than money due at some future date.
There are “time value of money” calculators which will help you compute the present and future value of any given cash flow depending on such factors as the desired rate of return, or yield, the terms the loan was written at and for how long, the number of payments remaining, and the outstanding balance.
We’ll cover this in other videos, along with actual calculator examples, so be sure to subscribe to this channel if you haven’t already.
Let’s illustrate a brief example. Say you’re making regular monthly payments on a $50,000 loan amortized at 5% over 20 years (when you do the math, your monthly payment amount comes out to $329.98).
And, let’s say that, to date, you’ve made a year’s worth of payments, so the present balance owed is currently $48,506.34 (you can work this out on an amortization schedule).
A new investor offers to buy the note from the bank and take over the remaining 228 payments, but he wants a 7% yield on his money. He offers $41,549.13, which is a discount of $6,957.21 off of the present balance (you can work this out on a “time value of money” calculator and I’ll explain this principle and show you how to do this on an actual financial calculator in another video so check out my channel).
The bank accepts the offer, and now your payments are going to the new investor instead of the bank.
Let’s take a look at how the numbers worked out on this transaction.
The bank originally lent you $50,000 at 5%. If they had held the loan to term, they would have collected 240 payments x $329.98 = $79,195.20 – $50,000 = $29,195.20 over the life of the loan.
To this point, you’ve been making payments for a year.
So, for the remaining term, written at 5%, the bank stands to collect 228 more payments x $329.98 = $75,235.44 – $48,506.34 (principal still owed) = $26,729.10.
Now, let’s take a look at the new investor’s numbers. For a 7% yield, the investor pays $41,549.13 for the remaining 228 payments. Over the remaining term, he stands to collect the same 228 payments x $329.98 = $75,235.44 – $41,549.13 = $33,686.31 which is almost 7 thousand dollars more over the life of the loan than the bank would have collected.
The new investor has only 41 thousand 500 and change invested, while the bank had 48 thousand 500 and change invested. The smaller cash outlay raises the rate of return for the investor. So, the important concept to remember is that by raising the rate of return by just a little, the investor’s bottom line goes up a whole lot.
What’s more, the note is backed by the security of real estate. It’s secured by a mortgage, which is secured by your home. If you should ever default on your future payments, the new investor has the same rights to foreclose that the original bank would.
You, the payor, may not even be cognizant of the loan ever having changed hands because sometimes these note purchases are quite seamless. You’re just making your monthly payments as you always have, which in some cases can still be routed through the same servicing company, going to the same address.
This is note investing in a nutshell, and, this is not unique to bank notes, nor is it confined to only big players. The “little guy” or individual investor can get in the game, too. Private seller-financed notes are bought and sold all the time in just this way on the secondary market. These are notes that were originally taken back by private sellers in “for sale by owner” situations. This is the market that we’re in.
Note investing can be an excellent way to invest in the security of real estate without the inherent hassles of hands-on property management. Since you are dealing only in the underlying paper which is secured by the mortgaged property while escaping the day-to-day operation and maintenance of the property itself, note investing may well prove to be the perfect home based business for you, since you’ll have the ability to work from virtually anywhere, regardless of your physical location..
There are several ways to earn profits in discounted notes.
You might start with flipping. Flipping means you find a note and then sell it to someone else instead of buying it. There are investors who will buy the notes you send them and pay you referral fees for every closed deal. You can easily earn thousands of dollars per transaction by acting as the “finder”. All the while, you have an opportunity to learn the backend part of the business (meaning all the various steps, assigns, paperwork, due diligence) by following the investor’s lead while you’re earning referral fees. You can amass capital this way which can then be used to invest in notes for yourself once you have a few note transactions under your belt and know what you’re doing.
OK, I kept this to under 5 minutes, as I promised.
But if you want to learn more, we have a ton more information on getting started in notes yourself at NoteInvestors.com. Be sure to check us out there, and also don’t forget to subscribe to this channel so you don’t miss any of my upcoming videos, you’re going to love them.
Bye for now.