As I’m sure we know well, when a homeowner takes out a mortgage to buy a property, the lender issues a promissory note that outlines all the terms of the loan.
That note is an asset. It gives the lender the right to receive the monthly mortgage payments that the homeowner makes, and it spells out the lender’s security interest in the underlying home as collateral should the homeowner default on their obligations.
However, lending institutions today only keep a small fraction of the mortgages they originate on their own balance sheet. That’s because holding mortgages reduces the capital they have available to make new loans, which is their core business.
For this reason, lenders sell most of the mortgages they create shortly after origination. And who do they sell these mortgages to?
Well, 80% of the time they package a group of mortgages together into mortgage-backed securities through a process called securitization. But the other 20% of the time, they sell each individual mortgage to investors.
Most often those investors are insurance companies, pension funds, and hedge funds. They tend to buy large blocks of mortgages in one sitting. But here’s the thing – there are no accreditation requirements. And that means individual investors can also buy mortgages at will. Anyone can engage in mortgage note investing.
Of course, most investors don’t realize that this is an option. And the prospect of buying a mortgage seems daunting. It sounds like it requires a lot of work and specialized knowledge. Not to mention the cost – doesn’t it require deep pockets to buy somebody’s mortgage?
This apparent barrier to entry has kept the realm of mortgage note investing a secret for a long time now. But, as is often the case, the reality paints a much different picture.
We’ll address this reality in tomorrow’s entry, and I’ll lay out exactly how mortgage note investing is within the reach of regular investors – even those who might not have tons of money lying around to invest.
But for today, let’s talk about why mortgage notes make for an attractive investment.
The Secret of Mortgage Note Investing
When you invest in a mortgage note, you’re buying somebody’s mortgage. That means you effectively become the lender. You own the promissory note that says the principal & interest (P&I) portion of the mortgage payment is owed to you each month.
So the homeowner’s monthly payment becomes your cash flow. When they make their payment, it comes to you.
This makes mortgage notes an alternative investment that one can make to create extra income. They are similar to bonds in some ways, except their value is tied to future cash flows and backed by the underlying real estate.
I like to think of mortgage note investing as the other side of the coin compared to owning investment real estate – a more common asset class.
When you own rental real estate, tenants pay you rent each month. But then you have to pay the mortgage, taxes, and insurance costs from that rent. And you’re on the hook to cover all the repairs and maintenance expenses that arise over time.
When you own mortgage notes, you don’t have to worry about any of those items… because the homeowner is responsible for them.
As the note holder, you simply collect the P&I payment each month with no strings attached. And now that interest rates have normalized, the cash flow from mortgage notes is considerably higher than that provided by rental properties.
So mortgage note investing can provide a steady stream of monthly income from an asset that is tied to physical real estate – not the financial markets. We’ll look at a specific example later this week to illustrate the potential.
And as a reminder, we’re hosting a strategy session to dive even deeper into the secret world of mortgage notes next week. It’s happening at 7:30 pm Eastern next Wednesday, October 8.
My goal with the strategy session is to walk through the ins and outs of investing in mortgages from start to finish. This will include a primer on action steps and risk management.
My hope is that everyone will walk away from the session with the tools they need to start building extra monthly income with this asset class.
If you would like to join us, you can get more information at https://phoenicianleague.com/session
-Joe Withrow