When purchasing mortgage notes, investors have two options — buying from an institutional note seller or from a private note seller. While buying mortgage notes, especially non-performing loans, has grown in popularity thanks to the aftermath of the Great Recession, note investors often overlook the private note market in favor of institutional loans. Investors who are willing to spend the time learning how to work with private note sellers will find an almost untapped opportunity in this lucrative niche.
Read on to find out what a private mortgage is, how the purchase process works, where you can find private sellers and understand the pros and cons of buying notes from a private note seller.
What is a private mortgage note?
Private mortgage notes are created when individuals or non-lending companies loan money to buyers to help them purchase real estate owned by the lender or by a third party. If the lender owns the real estate being sold, the process is referred to as owner financing or seller-financing.
Buying a mortgage note from a private note seller
Buying a mortgage note from a private note seller is a completely different process than buying from an institutional lender or large hedge fund. While the private note owner may have multiple notes to sell, it’s more common to buy notes from these sellers one at a time.
Because it’s a private market, the purchase process varies widely. Private note sellers who have performed hundreds of these transactions may have quality standards, policies and procedures that rival that of an institutional sellers, even though they face fewer origination, underwriting and loan servicing regulations.
Loan terms, documentation and underwriting can also vary. Borrower characteristics, the intended use of the property being purchased and the number of notes the private lender creates in any given year all determine the procedures, protocols, and term requirements that may need to be incorporated into the loan. The note seller may have used an attorney, title company, or licensed mortgage originator to create and underwrite the loan to the current regulatory guidelines and standards. Or, they may have created the loan themselves without any guidance whatsoever. Pay history or original loan documents may or may not be available.
Private note buyers must ensure that all regulatory requirements have been met because their ability to collect on the private notes they purchase will depend on them. Minor oversights may be fixable and the seller will accept a lower price to reflect the additional effort and risk the buyer will have to take on because of the errors. Other private notes might have been so mismanaged that they will be uncollectible if the borrower stops paying altogether.
In addition, many private sellers are unaware that they can sell their mortgage note so your purchase process might also include educating the note holder on the benefits of selling their loan now and helping them understand the process involved. And because of their inexperience, providing them with a detailed checklist of the documentation you will need to conduct proper due diligence and complete closing is extremely helpful in creating trust and facilitating a smooth transaction.
Where to find a private note seller
Most investors use direct marketing to contact potential note sellers. This can include postcards, letters, emails, cold calling or any combination of these methods. Whatever the method of choice, the investor makes direct, repeated contact with private note holders who may have a desire to sell now or in the future. There are also several online marketplaces that allow individual note owners to sell any mortgage notes they own.
Benefits of buying from a private note seller
One of the biggest benefits of buying from a private note seller is the potential discount. The private market place currently demands a discount in some form or another, even for a performing loan, so the investor buying the note can often achieve a higher return. It’s also a larger market than most investors realize, often with less competition than the institutional market as mentioned above.
Drawbacks of buying from a private note seller
While the opportunity for increased returns exists, it comes with a less organized and streamlined process. The quality of the loan you are buying is also not guaranteed. This requires more homework and effort on the buyer’s part to identify any potential issues with the loan that must be rectified before closing. Many private note sellers are older and this could force you to meet face-to-face, communicate by phone, or rely on the US Mail to get the transaction closed, all of which extend the closing timeline.
Direct marketing also requires upfront working capital to purchase potential note seller leads, to send letters or postcards, or to conduct an online marketing campaign. You have to spend money to make money with this strategy.
While many aspects of the note buying process are the same no matter who the note seller is, there are a few significant differences. Tracking down the note seller, creating a relationship with them, conducting your due diligence, and closing the sale will all vary depending on your seller. But both can be profitable investment sources so the “best” choice will depend upon the investor’s resources, abilities, experience, and preferences
Want to learn more about note investing?
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If you're interested in learning how we are able to invest and profit by creating, buying, and selling mortgage notes regardless of the economic climate, visit our website, where we show you how you can become a note investor through our online note investing education program, Note Investing Academy.