3 Ways to Invest in Secondary Mortgage Notes | The Paper Source University
Creativity will be rewarded in the lending sector.
Back in 2005, it was clear to those of us who looked closely that the housing market was sitting on unstable ground. When lenders are freely lending money to borrowers with low credit scores (in the 500s) at combined loan-to-value (LTV) ratios of 103 on a stated income with no proof of income and no money invested in the property, they are lending to people who cannot afford the houses they are buying. Suffice it to say, the housing market took a dive, then the financial markets melted down, and lastly, the Great Recession followed.
Those events led to the exponential growth of the secondary note space, and they also permanently altered how lenders treat borrowers with “imperfect” loan applications. Secondary mortgage notes are made to home-loan borrowers who are, ultimately, not qualified to get “traditional financing,” however that is defined in the current market. They may have a credit issue (too low) or a down payment issue (not enough). Whatever the issue is, they have a big toe sticking outside the bank’s lending box, and the bank will not “play ball” so that they can get a traditional mortgage.
Key Insight: People who are buying with seller-financing (secondary notes) are buying a house with the understanding that the financing they are getting could be temporary if they become an institutional-quality homebuyer who can refinance into a more conventional mortgage note. They are incentivized to do this because it is a less expensive borrowing option. They are willing to take the secondary loan terms because they view them as payment for the opportunity to own a home while repairing their credit issues.
In my experience, these borrowers are almost universally amazing people who will pay their home loans on time and in full. Furthermore, they are great borrowers, under the right set of loan terms, because they sincerely want to be homeowners and value the opportunity to make that purchase. They also tend to be willing to pay above-market interest rates, put down higher down payments, and pay higher prices for the properties themselves. That makes these buyers highly desirable, if you know how to work with them.
Most investors don’t, and they miss out on premium sales prices, highly collateralized investment opportunities, and the chance to improve our national homeownership statistics along the way.
If you’ve never considered investing in secondary mortgage notes, here are three ways you can do so:
- Create notes yourself: When you are willing to create notes via seller-financing or other creative lending structures, you automatically create your own custom population of eager buyers who are pre-qualified to be willing to pay above-market prices on the loan and on the property. You also bring speed to the equation in any deal since secondary notes usually may be obtained more quickly than traditional bank financing.
- Buy performing notes and collect the monthly income: Purchase seasoned mortgage notes with a history of on-time payments, then collect the monthly income. Over time, you will collect far more than you paid.
- Buy non-performing notes, “rehab” them, and then collect the income or sell them to another investor: Note investors often purchase non-performing mortgage notes at a discount, then work with the borrower to create a situation in which they begin paying their monthly note once again. When a note is restored to “performing” status, it may be sold for far more than you bought it originally.