Ideas for a better investment
Buying Mortgage Notes: Set This Up 1st
Before you start buying mortgage notes it's important to have a few things figured out. Learn what things to do 1st, as a new note investor.
11 min read
Learn what you need to set up before buying mortgage notes. This information is taken from a Podcast episode we did on things to do prior to buying your first mortgage note.
Purchasing mortgage notes is a great way for anyone to diversify their current investment strategy and make passive income.
There are a lot of benefits to buying mortgage notes and they differ from investing in real estate. One way that mortgage notes differ from other forms of real estate is that they are secured by the physical property. (Unless you as a real estate investor and own the home, you don’t have this same advantage).
What does that mean?
That means that if the person in the house (borrower) stops paying their mortgage you have a legal right to the money owed to you. This is usually done through a foreclosure process. At that point, you would have the house in your possession to either fix and flip, sell as is, rent out, or seller finance.
This is unlike other investments (financial markets), where if your investment goes to zero and you sell you’ve lost your money.
In this article, we’ll outline some essential steps to take before buying mortgage notes.
Before Purchasing a Mortgage Note
1.) Education & Knowledge
The first step in purchasing mortgage notes is to educate yourself on the topic. Follow industry news, subscribe to relevant newsletters, blogs, YouTube channels, and podcasts, and attend industry conferences and events to stay up-to-date. There are many resources available for education online and in print that can help you gain a basic understanding of the note investing process. It’s important to understand the different types of notes (performing and non-performing) and how they work, as well as the legal and regulatory frameworks that govern the mortgage note industry.
Note Investing Education
There are many note investing educators online and you will want to have at least the basics down before you jump in head first into mortgage notes. You can always dive into note investing education with Paperstac Academy, the ultimate note investing course designed to take you from beginner to purchasing your first note. We also have our YouTube channel as well packed with educational content on mortgage notes.
2.) Investment Goals and Risk Tolerance
Determine your investment goals and risk tolerance level before investing in mortgage notes. You need to know your objectives and how much risk you are willing to take on.
3.) Setting up Your Capital Before Buying A Mortgage Note
The second thing to have set up prior to purchasing a mortgage note is determining your capital requirements and getting it set up. You need to know your budget for the type of note you’d like to purchase.
This involves knowing what kind of asset, (performing or non-performing) you’d like to purchase.
Each performance type has different capital restraints.
For a performing mortgage, you want to have reserves after the purchase. This includes minor things such as servicing setup and boarding and any other ancillary fees that may be required (recording fees, etc).
With a non-performing asset, you want to have more reserves set aside. The funds are for the possible loss mitigation proceedings with or without a servicer. It will also require higher servicing costs with non-performing loans. Lastly, in the case of having to go to a foreclosure, you’ll want funds to cover that cost as well.
Key Takeaway:
Before buying mortgage notes, it’s important to determine your capital requirements. This will involve deciding what type of asset you want to purchase (performing or non-performing) and how much money you are willing to invest. Keep in mind that non-performing notes may require more capital upfront for potential loss mitigation proceedings and higher servicing costs.
Recommendation For First-Time Note Buyers
As a recommendation for first-time note investors, it is a good idea to start with a performing note. Purchasing a performing note will get you familiar with the process of note investing.
4.) Choosing A Geographic Location
Once you know what performance type you want to purchase, it is now the question of where you’d like to purchase mortgage notes. A lot of first-time buyers would prefer to purchase in their local area. This can be good if possible but sometimes this is just not the case. It also might not be ideal if you’re in a state that has certain restrictions that can make it difficult to use your area as a starting point.
For example – in Georgia, you need a license to collect payments.
You also will want to review if your state is a judicial or a non-judicial state (this is the foreclosure guidelines for each state).
With that said if you can purchase your first asset locally that is a great starting point. If however, this is not possible the next best thing would be to purchase a mortgage note where you have boots on the ground.
With “boots on the ground”, think maybe some familiarity with the location where you either know people such as contractors or realtors if needed or you have family members there.
The goal with keeping things local is to try to stack the deck in your favor. If you’re familiar with the area, that is only going to be a benefit if something goes wrong.
5.) Find the Right Asset
It’s not ideal to buy the first note you see (unless it is an amazing deal) just as it is not ideal to constantly evaluate only looking for home run deals.
You want to look at a number of different possible deals before you purchase mortgage notes. This will help you learn how to evaluate different mortgage notes.
Finding Mortgage Notes On Paperstac
There are many places to find mortgage notes but one of the easiest and most transparent ways to purchase a mortgage note is going to be here at Paperstac.
We’ve got a lot of protections for first-time mortgage note buyers. We offer a transaction area where you can communicate with a seller securely and know that there is a timestamped audit trail of your conversations.
You will also be able to review the collateral file on Paperstac after making an indicative offer. Any Paperstac transaction will include escrow as well. There is also the choice of using a 3rd party escrow company to keep your funds secure and safe until you have had a 3rd party do a collateral verification.
In this collateral verification process, they are looking for original documents such as the mortgage, the note, and a title policy.
After this, the collateral verifier will provide color copies of the collateral file. At this point, you still have the opportunity to pull out the transaction if you find something that was presented by the collateral verifier was different or inaccurately reported prior by the seller.
6.) Submitting an Indicative Offer
Now that you have these three things:
1.) Have your capital in place
2.) Know geographically where you are going to look to purchase mortgage notes.
3.) Have a source for mortgage notes
It’s now time to start making indicative offers on different mortgage notes that meet your buying criteria.
What Is An Indicative Offer?
An indicative offer is an offer made to a seller that you would pay for the mortgage note as long as the value, title, and pay history (if a performing mortgage) all check out.
If your indicative offer is accepted by the seller, this is when you will start ordering due diligence documents. The due diligence documents you want to order would be some sort of property valuation report or broker price opinion and an owners & encumbrance report.
7.) Performing Due Diligence
Conduct thorough research on the mortgage notes you plan to invest in, including the borrower’s credit history, the property’s condition, and the market in which it is located.
Evaluating The Collateral File & Servicing Notes
At this point, this is where you’d want to ask to see the collateral files. As well as pay history and servicing notes if available. From this, you want to figure out the story of the borrower in the property. This is very important to figure out before you purchase mortgage notes.
Definition of Due Diligence Documents
- Collateral File: This includes all of the files that were included with the origination of the mortgage.
- Pay History: This document shows the exact dates of why payments were made to the Servicer.
- Servicing Notes: Any correspondence between the Servicing company and the borrower is recorded and stored in the Servicing notes. Reading these notes helps you understand who is living in the house and can provide insights into possible exit strategies.
- BPO: A Broker Price Opinion provides general information about the area, demographics, and comparable houses in the area, which helps establish the value of the property.
- Title Report: This report, also known as an Ownership and Encumbrances Report, verifies if there are any liens, taxes owed, or judgments on the property from the last property purchase to the current time.
Ordering Due Diligence Documents Before Buying Mortgage Notes
Focus on the process of doing due diligence and not the results of what is to come. From focusing on the process you will learn so much about possible exit strategies you could take at a later date. Some of the best exit strategies that Rick Allen has had were from reading the collateral files and the servicing notes over a couple of times.
BPO
In the process of purchasing a real estate note, it is good to make sure you get what is called a BPO (Broker Price Opinion). A BPO is similar to when you get an appraisal for a house. The big difference is by law you can’t enter the house to see the inside.
Instead, you will get general information about the area, the demographics of the area, and see what has sold in that area. When viewing a BPO be sure to see how far out the person that created the BPO is using houses for comparables. Something that sold 5 miles away might not be the best example of what the house you’re looking to purchase might sell for if it needs to be sold.
Establish Value Before A Note Purchase
It is also a good habit to do your own research, go to Realtor.com and Zillow.com. See for yourself what houses have sold for in that area. Remember that this is an estimate. Be cautious, always lean on the side of the house that comes in the lowest. You want that to be your basis not the one that sold for the most.
Establish Value Before A Note Purchase.
The reason is that you’re unable to see the inside of the house. You don’t know if the houses that sold for more have had improvements made to them.
Title Report
In addition to ordering a BPO, you should also purchase a title report. Most times the sellers do their best to provide you with the needed documents to know if the title is clear. But, it is on you to verify this to be true. The Title Report you want to order is called an O&E Report (Ownership and Encumbrances Report).
In this report, you are checking to see if there are any liens, taxes owed, or any judgments on the property from the last property purchase to the current time.
Be sure to review this document in depth, this could be a make-or-break situation. Especially look to see if there are any liens from the city or the HOA.
If everything checks out then it is safe to move forward with your indicative offer. If on the other hand, something comes up in either report, you can further negotiate with the seller. Or cancel the transaction if there is not a resolution to the issues.
8.) Heading Into a Closing With a Seller
If everything checks out and you’re still wanting to close with the seller, it is now time to move into a closing.
Things to consider in a closing are the following:
- Where will the collateral files be stored?
- Who will be servicing this loan?
- What account to use to pay for this mortgage note?
Having all of these set up prior to entering into closing will help to have a smooth closing process.
These are a few things you can do before buying mortgage notes that can really make a big difference in your success as a beginner note investor.
This blog post is based on the podcast episode provided below.
More Episodes To Watch
Watch This Paperstac Podcast Snackable Episode on Buying Your First Mortgage Note
Be sure to subscribe to the Paperstac YouTube channel for more helpful tips on mortgage notes and real estate investing. For more in-depth information on note investing you can read more from the Paperstac Blog. If you are looking for a great note investing course learn more about our Paperstac Academy which takes you from beginner to purchasing your first mortgage note!
This blog post was co-written by Brett Burky & Jessica Gold from the Paperstac Team.
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