Note investing means buying debt instead of property. When someone takes out a mortgage or other loan, that loan creates a legal document called a promissory note. The original lender can sell that note to another investor, who then collects the borrower’s monthly payments. As a note investor, you step into the lender’s shoes: you own the right to receive principal and interest on the loan without ever owning the underlying real estate.
This corner of investing attracts people looking for passive income, higher yields than traditional bonds, and exposure to real estate without the headaches of being a landlord. But the mechanics, risks, and potential rewards differ significantly depending on the type of note you buy.
How a Note Investment Works
Every mortgage has two key documents: a promissory note (the borrower’s promise to repay) and a mortgage or deed of trust (the security instrument tied to the property). When you buy a note, you purchase both. The borrower typically doesn’t know or care that the note changed hands. They keep making payments, and those payments now flow to you instead of the original lender.
The critical detail is that notes almost always sell at a discount to the unpaid principal balance of the loan. If a borrower still owes $100,000 on their mortgage, you might pay $70,000 to buy that note. You still collect the full payment amount based on the original $100,000 balance and its interest rate. That spread between what you paid and what you collect is where the real return comes from. According to note investment analysts, buying at a discount can produce yields of 10% to 15% even when the borrower’s interest rate is only 6%.
Performing Notes
A performing note is one where the borrower is current on payments. Every month, the check arrives on time. This is the more straightforward side of note investing: you buy a stream of reliable income at a discount and collect until the loan is paid off, refinanced, or the property is sold.
Performing notes typically sell for 70% to 90% of the unpaid principal balance. The discount is smaller because the risk is lower. You’re buying a loan that’s already working. Your main job after purchase is making sure payments keep flowing, property taxes stay current, and the borrower maintains insurance on the property. Many note investors hire a loan servicer (a company that handles payment collection, statements, and escrow) for a small monthly fee so they never interact with the borrower directly.
The appeal here is predictability. You know exactly what payment is coming, when it’s due, and what your yield will be if the borrower pays as agreed. It functions similarly to a bond, but secured by real property.
Non-Performing Notes
A non-performing note is one where the borrower has fallen behind on payments, typically by 90 days or more. These notes sell at much steeper discounts, often 40% to 70% of the unpaid principal balance, because collecting on them requires work and carries real uncertainty.
Non-performing notes involve more risk but potentially more reward. When you buy one, you’re essentially buying a problem to solve. There are several possible outcomes, and experienced note investors pursue whichever path makes the most financial sense:
- Loan modification: You renegotiate terms with the borrower (lower rate, extended timeline, reduced balance) to get them paying again. A re-performing note can then be held for income or resold at a higher price than you paid.
- Short payoff: The borrower pays a lump sum that’s less than the full balance but more than you paid for the note, and the debt is settled.
- Foreclosure: If the borrower can’t or won’t pay, you can foreclose and take ownership of the property, then sell it or rent it out. This is the most time-consuming and expensive route, and foreclosure timelines vary widely by state.
- Deed in lieu of foreclosure: The borrower voluntarily transfers the property to you, skipping the formal foreclosure process.
Each of these strategies carries different costs, timelines, and legal requirements. Non-performing notes are not passive investments. They demand due diligence, patience, and often legal guidance to navigate borrower protections and state-specific foreclosure laws.
First-Position vs. Second-Position Notes
A note’s “position” refers to its priority in the event of foreclosure. A first-position note (also called a first lien) gets paid before any other debts secured by the property. If the property sells at foreclosure for less than all the liens combined, the first-position holder gets paid first.
A second-position note sits behind the first mortgage. If the borrower defaults and the property doesn’t sell for enough to cover both loans, the second-position holder may get little or nothing. Because of this added risk, second-position notes sell at deeper discounts. Some investors specialize in second-position notes precisely because the entry price is low and the upside can be significant if the borrower resumes payments or if there’s enough equity in the property to protect the investment.
Before buying any note, you need to verify the lien position through a title search. You also want to confirm the property’s current market value relative to all outstanding liens. A note secured by a property worth far more than the total debt is a much safer bet than one where the borrower is underwater.
Due Diligence Before Buying
Note investing is not as simple as picking a note off a list and wiring money. The due diligence process is where deals are made or avoided, and skipping steps can be expensive. Here’s what experienced note investors evaluate before committing:
- Payment history: How consistently has the borrower paid? How far behind are they if the note is non-performing?
- Property value: An independent assessment of the property’s current market value tells you how much collateral backs the loan. If the borrower owes $80,000 and the property is worth $120,000, you have a cushion. If the property is worth $60,000, you could lose money even in foreclosure.
- Title search: This confirms the lien position and reveals any other claims on the property, such as tax liens, mechanics’ liens, or judgments that could complicate your investment.
- Loan documents: Review the original note, mortgage, and any modifications. Errors or missing documents can create legal problems when you try to enforce the note.
- Borrower’s situation: For non-performing notes, understanding whether the borrower is in bankruptcy, has abandoned the property, or is simply behind temporarily affects which resolution strategy will work.
- Property condition: A drive-by inspection or photos can reveal whether the property is occupied, maintained, or deteriorating. A vacant, damaged property is worth less as collateral.
Where to Find Notes for Sale
Individual investors can access mortgage notes through several channels. Banks and credit unions periodically sell pools of loans they want off their books, though these institutional sales often involve large minimums and go to established buyers. For smaller investors, online note marketplaces and trading platforms connect buyers and sellers of individual notes or small pools. Some platforms specialize in residential mortgage notes, while others list a mix of commercial notes, land contracts, and seller-financed paper.
Networking is another common path. Note investing communities, conferences, and online forums are where many deals originate. Hedge funds and larger note buyers sometimes break up pools and resell individual notes. Private sellers who financed a property sale themselves may also look to cash out by selling the note they hold.
Pricing varies based on the note’s performance status, lien position, borrower credit profile, property value, and the remaining loan term. There’s no centralized exchange with transparent pricing, so comparing multiple opportunities and running your own numbers is essential.
Costs Beyond the Purchase Price
The note’s purchase price isn’t your only expense. Budget for a title search (typically a few hundred dollars), legal review of loan documents, and loan servicing fees if you hire a servicer (usually $15 to $40 per month per loan). For non-performing notes, you may also face legal fees for foreclosure proceedings, property inspection costs, and potentially property taxes or insurance premiums that the borrower has stopped paying. These carrying costs can eat into returns quickly if a workout drags on for months.
On the income side, note investing can be tax-efficient depending on how you structure it. Interest income from notes is taxed as ordinary income, but if you acquire a property through foreclosure and later sell it, different tax rules apply. Some investors hold notes inside self-directed IRAs or solo 401(k) accounts to defer or eliminate taxes on the income.
Who Note Investing Is Best For
Note investing rewards people who are comfortable with paperwork, legal processes, and analytical work. It’s less hands-on than owning rental property (no tenants, no maintenance calls) but more involved than buying index funds. Performing notes suit investors who want predictable income without property management. Non-performing notes suit those willing to do the legwork of borrower outreach, negotiation, and potentially foreclosure in exchange for higher potential returns.
Starting capital varies. Individual residential notes can be found for as little as $10,000 to $20,000, though most performing first-position notes require significantly more. Diversifying across multiple notes, which reduces the impact of any single borrower defaulting, requires a larger portfolio. Some investors start with a single note to learn the process before scaling up.