Real Estate Note Investing in 2025: Find Yield, Avoid Ponzi Schemes

 

When I talk to people about investing in mortgage notes, I usually get a confused look: "Wait, what do you mean? I have a mortgage on my house, is that what you're talking about?" My answer is: "Kind of like that, yes. But when I buy a mortgage note, I'm the bank, not the borrower!" Then, they become curious!

But even though mortgage notes can return 9%, 14%, or even up to 20% rates of return or more – with a fixed rate of monthly ACH income! – why don't more people know about these investments, or participate in them? After all, with no volatility and higher rates than stocks or bonds, they seem like a sure bet.

Not so fast.

While these investments are perfect for some, they're definitely what I would call 'alternative' investments, in that you can't buy them from your Robinhood account, and you can't trade them like a stock on your mobile app. If you want to get into mortgage note investing, you're going to need a little creativity, and to put in a little work to actually find good notes to buy.

This article will go over:

• what mortgage notes are
• how to invest in them
• the risks of buying private notes
• why investors should consider either investing in notes through funds, or by buying what are called 'partials'.

That way, you're not dealing with foreclosures and needing to potentially make debt collection calls to borrowers, yourself. (Because then it's not an investment, it's a business!)

Let's get into it.

What are Real Estate Mortgage Notes?

A real estate mortgage note is like an IOU backed by a property. It's the property owner saying "I promise to pay you back this loan, and if I don't, you can take my property." Simple as that.

A mortgage note is actually made up of two parts:

1. The Promissory Note: The borrower's promise to repay the loan, including the interest rate, monthly payment amount, and repayment schedule.
2. The Security Instrument: This is either a mortgage or a Deed of Trust, which creates a legal lien on the property. If the borrower doesn't pay, the lender can foreclose on the property. With a Deed of Trust, the lender can sell the property without needing to go through the courts (a non-judicial foreclosure). But with a mortgage, the lender has to follow a legal foreclosure process.

For example, let's say you're buying a house that's $270,000. You only have $55,000 cash, so you borrow $215,000 from a lender. To get that money, you sign a promissory note saying you'll pay it back, and a mortgage tying your promise to your new house. If you can't pay, the lender can take your house as payment. That's the gist of it!

Again, that's how a mortgage note works when you're the borrower – but remember, you're not borrowing, you're on the opposite side of this transaction as the lender.

What Are The Different Types of Notes?

The main kinds of real estate notes you can invest in are called Performing Notes and Non-Performing Notes. In the industry lingo, you'll also hear about "senior liens" ("first liens"), and "junior liens" ("second liens"), too. All that means is that the senior position has less risk, and gets paid first if there's a loss, so be careful when buying second-position notes.

Performing Notes (PN): These are notes where the borrower is making their payments on time and according to the schedule. These are low-risk, stable income investments, and they're the bread and butter of most private note investors' portfolios.

Non-Performing Notes (NPN): These are notes where the borrower has stopped making payments, usually defined as being at least 90 days behind. These are higher-risk, but they often offer higher returns because you can buy them at a steep discount. The strategy here is to either renegotiate the loan terms with the borrower to get them paying again, or to foreclose on the property and sell it to recoup your investment.

What Are The Ethics of Buying The Rights to Someone's Mortgage?

Look, it's easy to hear about "buying non-performing notes" and foreclosing on properties, and think to yourself: "That sounds a little, you know… predatory." However, I've spoken with a lot of NPN fund managers who I believe, based on the conversations I've had, help countless numbers of homeowners stay in their homes.

Here's the background of why buying NPNs doesn't have to be a predatory practice. Remember, the mortgage note has already been sold to the investor, and the original lender has already made their decision to sell it. When a bank or lender decides to sell a non-performing note, it's usually because they don't want to deal with the foreclosure process, or they don't have the resources to work with the borrower to get them back on track. That's where the private note investor comes in.

Many private note investors specialize in working with borrowers to help them stay in their homes. They might offer loan modifications, forbearance agreements, or other creative solutions that the original lender wasn't willing or able to provide. In many cases, the note investor can offer more flexible terms than a big bank would, which can be a win-win for both the investor and the borrower.

Of course, there are also investors who are more focused on foreclosing and flipping properties. But even in those cases, the borrower has usually stopped paying their mortgage for a long time, and the property might be in disrepair or abandoned. In those situations, foreclosure might be the best option for everyone involved.

At the end of the day, investing in non-performing notes can be a way to help homeowners who are struggling, while also generating a solid return on your investment. It's all about how you approach it and what your goals are.

And that's just wonderful.

Advantages of Investing in Mortgage Notes

Investing in private mortgage notes can offer investors several advantages, especially if they are interested in generating a predictable cash flow. Here are some of the reasons why:

1. Be The Bank. Have you ever thought you might like to invest like a bank does? (Well, apart from First Republic and Silicon Valley Bank, that is.) This is your chance to take the other side of the home borrowing equation. Instead of signing up for years or decades of monthly payments, you're signing up for monthly cash flow.
2. Predictable Income: Private mortgage notes pay interest at a set rate, and you receive payments monthly according to the amortization schedule. This makes them ideal for investors who want a predictable income stream.
3. No Property Management: Woo hoo! No fixing toilets, no tenant relationships, no nothing. Well… except in the unlikely but possible event that you have to foreclose. It's out of your hands. The borrower is the property owner, therefore typically very incentivized to maintain their property and keep it in good shape.
4. Higher Returns: Since notes carry higher risk and are less well-known than traditional investments like treasury bonds or CDs, they almost always offer higher interest rates – generally even higher than bonds and fixed-income ETFs.
5. Security: Mortgage notes are secured by the underlying real estate property (be very careful if you're offered a promissory note investment that actually has no security except the borrower's promise to pay!). In case of default on a secured note, the investor can foreclose on the property to recover their investment. This collateral makes these notes relatively secure, unless the property can't be sold for enough to recover their investment – which can happen if you buy the wrong note.
6. Diversification: Buying private mortgage notes can offer a way to diversify an investment portfolio, and improve cash flow. They offer a different risk-reward balance than stocks, bonds, or traditional real estate investments, which might reduce overall portfolio risk.
7. Control: As a private note holder, the investor can pre-select the terms of the loan, whereas corporate or government bond ETFs are entirely out of your control. With private notes, investors can negotiate interest rates, repayment periods, and other terms, which can help you stay comfortable and in-the-know about how your portfolio is doing.
8. Discounted Purchase Price: Non-performing notes can be purchased at significant discounts, sometimes 10% to 80% off the unpaid principal balance. When you can work with the borrower to get them paying again, or when you foreclose and sell the property, you can make a substantial profit.
9. Low Correlation with Markets: Mortgage notes tend to have a lower correlation with stock and bond markets, which makes them a good diversifier in a portfolio. In periods of stock market volatility, these notes can provide a more stable source of income. Obviously if the economy is doing terribly, it's more likely you'll need to foreclose on the property in the case of default, but that likelihood has historically never gotten quite too high.
10. More Liquidity Than Many Alternative Investments: Even though it's harder to sell a mortgage note than a public stock or ETF, it's very possible. There are plenty of note buyers available for the average investor to sell to (although you might be taking a haircut if you do so).
11. Passive "Mailbox Money" Income: The best advantage of all! Once the mortgage note is purchased, it generally requires little management unless the borrower stops paying, making it a more passive investment compared to direct real estate investments, which require active involvement in management and maintenance.

Pretty good deal, if you ask me!

How To Buy To Real Estate Mortgage Notes

Buying Notes Directly

Unless you know of any private mortgage note holders that have good quality notes lying around to sell to you, you'll need to get out there and pound the pavement, in a sense, if you want to buy mortgage notes directly. Here are some ways to do that:

1. Visit PaperStac, NotesDirect, or one of the other mortgage note exchanges available.
2. You can also find a mortgage note broker through forums or trade shows, although make sure to do your due diligence, because the broker isn't going to do it for you
3. For-Sale-By-Owner property owners in your local area, as well as real estate investment groups, might also be good lead sources for you.

Investing Via a Fund or Platform

A much-easier way to invest in mortgage notes is to do so through a fund that professionally acquires and manages the notes. This is how to make note investing a truly-passive endeavor, since if you're buying notes directly, you've become a debt collector and administrator of a lot of paperwork.

Don't take these as personal recommendations, and do your own diligence. That being said, here are some of the places I've invested, directly or indirectly, in mortgage notes through a passive investment vehicle:

1. PPR Note Co
2. Yieldstreet
3. Fundrise

I receive monthly income from all of those, from my mortgage note investments. However, I generally shy away from tech-enabled investment platforms, and as such limit my exposure to Fundrise, Techvestor, and Yieldstreet etc to no more than 2-3% of my portfolio.

Buying Partial Notes From Note Holders

Yes, you can split a note into multiple parts! If this sounds complicated – it's not, really. Whichever mortgage servicer is managing the loan can break up the monthly payments they receive from the borrower, to multiple parties.

By buying part of a note, the investor is not responsible for managing the loan, collecting payments, or dealing with the borrower. The original note holder (or their servicer) handles all of that. The investor just receives their portion of the monthly payments.

Okay, but now: why would the mortgage note holder sell you part of their note, if the note is so great?

Primarily, because they'll offer you a lower rate of return than they're getting, and they get to recapitalize. For example:

1. Jack directly owns a Note with a balance of $25k, paying them a 16% yield.
2. Jill has a target rate of return of 12%, and wants to invest $25k.
3. Wonderful! Jill buys the Note from Jack for $25k.
4. Jack now receives a monthly 4% yield on a $25k note, while having no capital in the deal. That's kind of cool. They get to go buy other notes – say, ones that have even better returns. Or they can invest in whatever they'd like.
5. Jill reaches their target rate of return of 12%.
6. If anything goes wrong with the note and the borrower stops paying, Jack has to step back in and make Jill whole, so Jack had better be good for it and be ready to do that if necessary.

Jill gets the lower return in this scenario, but is more like an 'investor'. Jack gets a higher return, but puts more of their time at risk. Jack is more like a business owner.

Risks for Investors When Buying Mortgage Notes

There are a lot of risks to think about when you're looking at these ideal-seeming investments. Yes, they often have great rates of return, and passive income. While those are advantages, keep these risks in mind:

• The borrower stops making payments. This is the big and obvious one. If you own the note directly, it's on you to get the borrower to start making payments again, and you need to stay within legal debt collection guidelines as you do so. If you own a partial note, the person who sold you the partial will need to make you whole however it's listed in your contract.
• You bought a fraudulent note. If you didn't do your diligence on the property or the borrower, you might have bought a worthless piece of paper with no security in it. That's why due diligence is so important. It's much less likely that AT&T is a scam, than the guy you found online offering to sell you a note he owns.
• You need to foreclose, and the underlying property isn't worth enough to make you whole. Ouch. You need to foreclose, but when all is said and done, even after a hugely burdensome process with a borrower who didn't engage with you and abandoned the property in bad shape… you can't sell the property for enough to repay yourself. To add insult to injury, the foreclosure process made you incur legal and other fees.
• Interest rates increased and you tried to sell your note. This makes your note worth less, because people are less willing to buy fixed-rate debt when variable interest rates in the marketplace rise. Who would buy your 7% private note, if a 10-year Treasury pays 5.8%?
• The real estate market is way down. If the market is down and your borrower doesn't see any path to getting back on track from being underwater, they're much more likely to walk away from the property and leave you with it. Probably in bad condition.
• You tried to collect on your debt improperly in the wrong state, and broke the law. Remember, the borrower's location and property location matter. If you own notes directly and you say the wrong thing when you call the borrower, you could be breaking the law.
• You need cash now, and you're having a hard time selling your note for a good price. No Robinhood is coming to save you. The beauty and curse of mortgage notes is that they're not very popular. You're going to find many fewer buyers for them, if you need to unload the investment.
• You bought a partial note from a not-creditworthy owner. The borrower stops making payments, the note goes into default, and now you're trying to be made whole on your partial note investment from a note holder that can't make good.
• You forgot that this is still a real estate investment. If you have your entire portfolio in real estate, buying mortgage notes is only somewhat a form of diversification. It's still a loan… backed by real estate. Real estate goes up and down.
• You were expecting FDIC insurance. Nope. This isn't a bank account. There's no SIPC, FDIC, or any other acronym coming in to save you if things go bad. You're on your own with your wits and, hopefully, a good attorney.
• This part of the industry is lightly-regulated. This isn't like buying a home you live in and getting a mortgage for it from a bank, where the federal government is controlling a lot of how banks and brokers can lend to you. Now you're on the other side. If someone sells you a bad note and runs off, you're going to have a hard time getting anything back.

That's quite the list. Remember, there's no free lunch in this world: if you learn intensively about an asset class, especially about how to manage your risk, you'll give yourself a much better shot.

And that's exactly what I recommend you do: read, consume information, experiment with small amounts of capital, and: network, network, network!

Conclusion

Buying real estate mortgage notes as investments can be a great addition to your portfolio, or it can even be a business that you actively manage. Don't forget about the key risks involved, do plenty of diligence, and – most importantly – enjoy this asset class for what it can be, at its best: a wonderfully-passive vehicle and a relative secret among the average crowd of investors.

Good luck.

- Alex