Mortgage Notes | Different Classes And Types

There are two broad categories of residential real estate notes or mortgage notes that you can invest in – performing notes and non-performing notes. 

Performing Mortgage Notes 

If a borrower has paid their mortgage on time and never missed a payment, the note is “performing.” These are notes where the borrower is making their scheduled payments. As an investor, the primary focus is on current income. 

Performing notes are typically more expensive. While you can buy them at a discount, it’s typically only a slight discount from the remaining balance of the note.

Non-Performing Mortgage Notes

If the borrower has stopped paying their mortgage note, they’re in default. Typically, if borrowers haven’t paid in the past 90 days, their loans are categorized as “nonperforming.” Non Performing notes are sometimes called distressed notes.

These are generally sold by banks and other financial institutions and are sold at generally very deep discounts, perhaps between 50-90%. Since the borrower is not making their scheduled payments, the goal as an investor is to either modify the loan in conjunction with the homeowner, reach a lump-sum settlement with the homeowner, or foreclose on the property if needed. 

Non Performing notes are often sold at steep discounts from the balance owed or the value of the property, whichever is less. Pricing is also higher on first-lien mortgage notes compared to junior liens. The more secure the position, the higher the price.

The Different Types of Mortgage Notes that are Most Common

Secured

A secured loan is a loan that uses assets as collateral. Because the property is being used as collateral, the mortgage note may include a lower interest rate and longer payment term. The lender takes less financial risk with a secured loan and can make a better deal with the borrower. A loan secured by a property is known as a collateralized loan.

Unsecured

The other type is an unsecured loan, with nothing to back them. If the loan is unsecured, there’s nothing collateralizing the loan.

Private Loan

In a private mortgage note, a borrower makes payments to an individual entity directly. A private loan may occur when the lender owns the property outright. In this case, the lender is less regulated and can set up the note to their liking.

Private financing is when an individual (as opposed to a bank) directly lends money to a borrower (usually to purchase a home) who either can’t or doesn’t want to get a traditional loan from a mortgage lender. 

The borrowers then typically make a monthly mortgage payment to the individual as they would to a bank.

Institutional Loan

An institutional loan is a loan from a traditional mortgage lender or bank. These loans are heavily regulated, and, therefore, the note must adhere to standard interest rates and payment terms.

An institutional loan means a bank or lending institution created the mortgage note. These loans have strict laws and guidelines for underwriting. They’re held to a higher standard than private loans and must comply with the Dodd-Frank Act and Bureau of Consumer Financial Protection regulations.

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