Overview
Lenders/investors want notes because, done right, they are very good income vehicles. With bank interest rates at less than 1% for CDs or savings accounts, a note owner can achieve higher rates of return than traditional banking or bond opportunities with the security of being backed by real estate if the borrower fails to pay.
Notes secured by real estate can be simply described as one person (borrower) promising to pay another person (lender) certain amounts of money (payments) over time (term) at a certain cost (rate). If the borrower doesn’t pay the lender as agreed, the lender may, through legal means, renegotiate the terms, or foreclose on the property.
The lender is subject to specific laws (federal and state) such as usury, fair collection practices, etc.
The borrower is subject to specific laws related to default.
For the note to be a good experience for all, the borrower and the lender need to follow the rules.
Rate of Return
Quite simply, if you own a real estate note for $50,000 at 10% interest payable in equal payments over 20 years, you will be receiving 10% on your money, plus, receiving a portion of your original principal back each month.
If you were to pay $40,000 for a real estate note with a current unpaid balance of $50,000 (you buy the note for a discount), you will be receiving a 13.5% return on your money, plus, receive a portion of your original principal back each month.
Risks
As with any business opportunity or job, there are always risks. In a job, you risk being fired or laid off. In a business, you risk losing suppliers or customers. In the note world, there are risks as well. The following represent some (but by no means all) of the risks:
- Pay more for the note than the real estate is worth. If you have to foreclose, you will incur legal costs, loss of interest, repair costs — if the home is not worth more than the total amount of all that could go wrong, you could lose money.
- Lend to a borrower who either can’t or won’t pay. Assuming that you haven’t paid more than the real estate is worth, this is just a hassle to foreclose, repair and resell the property.