A note is a promise to pay document. When homeowners have a mortgage there is someone who owners that mortgage/note. Originally its a large bank but that mortgage/note often gets traded.
Some of us homeowners or rental owners get annoyed when we have to send out mortgage and escrow checks to a different company when our note/mortgage changes hands. What typically has happened is that the owner of our note has traded it to another party. Majority of the times the company we (homeowner/landlord) are interacting with is just the servicer company. This servicer company is the intermediary who bugs us when we are late and manages our payments.
Those nasty companies that harass people who are late on their mortgage payments are typically not the servicing company but another contractor who specialized in collections of bad debt.
There are two main sides of note investing:
- Performing notes – where the homeowner is being good and making payments. This is a little more stable and similar to a yield play deal.
- Non-Performing nates – where the homeowner had gone off the rails and behind on payments. This requires some sweat equity to get the person repaying or might even be a total loss. Once a Non-Performing note has gotten back on schedule it is made back into a Performing note.
Non-Performing notes allow you to buy a note at a discount.
Yield is the interest rate your money is earning on an annualized basis. Yield is the way we compare other investments and notes because it measures the rate the money is being returned to you (cashflow during hold) and the entire term of those payments. This is why when I compare MFH deals I ask what is the total pro-forma 5-6 year return because it compares the cashflow plus the appreciation at a certain time interval. Again this is the yield.
Yield is different from ROI, Cash-on-Cash, and Internal Rate of Return. When buying notes at a large discount the yield will automatically be high. This is incorrect. If the face value of the note the borrower is paying on is low (single digit %) you can have a relatively bad yield (less than 10%).
Just like getting 75% off at JCPenny on a crappy $80 sweater when buying notes a discount is good but don’t get hung up on the amount of the discount. Focus on the yield.
Yield on a note (and the price you pay for it as an investor) takes into account:
- interest rate
- payment amount
- number of payments remaining
- purchase price
- method of amortizing (fixed or balloon)