What to Expect for Mortgage Notes This Year

What Drives Non-Performing Loan Supply?

The availability of non-performing loans in the secondary mortgage market is not random. It follows a predictable chain: institutional lenders originate mortgages, a percentage of borrowers default, those loans are charged off, and then they are sold to make room on the bank's balance sheet for new, performing originations.

The bottleneck in this chain is almost always regulatory. When financial reporting reliefs allow banks to suspend or delay the recognition of distressed debt -- through mechanisms like Troubled Debt Restructuring (TDR) suspensions or Current Expected Credit Losses (CECL) deferrals -- the pipeline slows. Banks hold onto non-performing loans longer than they otherwise would, and the secondary market goes quiet.

When those reliefs expire, the pipeline reopens. Banks must report their bad debt accurately, and the balance sheet pressure to sell distressed portfolios intensifies. For note investors, that means more product at better pricing. The supply-demand dynamic shifts in your favor.

This is the fundamental macro driver every note investor needs to monitor. The question is never whether banks will sell distressed debt. The question is when, and in what volume.

How Does Home Price Movement Affect Note Investors?

Home values are a double-edged sword in the note business.

If you already own loans, rising property values increase the collateral backing your position. More equity means more room for loan modifications, discounted payoffs, and other borrower-friendly resolutions. It also means your downside is better protected.

If you are buying loans, rising property values typically mean higher acquisition costs. Sellers price their portfolios against collateral value, so when homes appreciate, the cost of entry goes up.

The ideal environment for an active note buyer is one where property values stabilize or soften modestly while the supply of non-performing loans increases. That combination compresses pricing on the acquisition side while maintaining enough equity to support profitable resolutions. You make your money when you buy mortgage notes -- and the macro environment determines what you pay.

What Does the Investment Spectrum Look Like?

Note investing is not a single activity. It spans a spectrum from fully passive to intensely active, and the time commitment, return profile, and skill requirements vary significantly at each level.

If you have limited capital and limited time, a fund or equity partnership gives you exposure to the asset class while you learn. If you have the time and are ready to build a business, buying and working out non-performing loans yourself is where the highest returns live -- but it requires the deepest skill set.

Partial acquisitions are an underappreciated middle ground. You buy a portion of the payment stream from a re-performing loan, sharing the risk and value with the note owner. It is a practical way to learn the mechanics of loan ownership without taking on the full complexity of a non-performing workout.

How Are Performing and Non-Performing Notes Priced?

Pricing methodology differs depending on whether a loan is cash-flowing or in default.

Re-performing loans are priced on yield. Like a commercial property evaluated by cap rate, a re-performing note is valued based on the annual cash-on-cash return it delivers. Senior liens trade at roughly 7.5% to 12.5% annual yields. Junior liens command higher yields -- 11% to 20% -- reflecting their subordinate position and higher risk. At a 20% yield, you break even in five years and capture all upside beyond that.

Non-performing loans are priced on discount. Senior liens are typically priced as a percentage of the property's fair market value, since a senior lien may resolve through the property via foreclosure. Junior liens are priced as a percentage of the unpaid principal balance, because junior liens more often resolve through the borrower -- via modification, repayment, or discounted payoff -- rather than through the property.

In both cases, equity awareness is critical. On the junior lien side, you never want to pay more than the equity protecting your position. Your invested capital to value (ICTV) percentage should remain below 100% to ensure your investment is fully secured by the collateral.

What Happens After You Acquire a Portfolio?

The first 90 days after a portfolio acquisition follow a predictable resolution arc. Here is what a real 288-loan portfolio -- $10.8 million in principal balance across 49 senior liens and 249 junior liens -- looked like through its initial collection cycle.

The Outreach Sequence

Three letters go out in succession:

1. Hello/RESPA letter (Day 1) -- A legally required notice from the loan servicer informing the borrower of their new servicer and where to send payments
2. FDCPA letter (Day 1) -- A Federal Debt Collection Practices Act notice disclosing the debt amount and servicer identity
3. Collection letter (Day 60-90) -- A soft outreach encouraging the borrower to engage before terms become less favorable

Each step escalates borrower awareness. The hello letter catches the low-hanging fruit -- borrowers who were already looking for a way to pay. The collection letter expands the net to borrowers who need a nudge.

Portfolio Results at 90 Days

The data confirms a structural difference between lien positions. Junior liens resolve through the borrower far more often than senior liens. After 90 days, nearly 10% of the junior lien portfolio had already achieved resolution -- these were borrowers ready to re-engage once they had a servicer to work with. Senior liens, by contrast, had 94% still at no-contact status, indicating that escalated legal steps would be needed.

What Types of Resolutions Emerged?

Among junior liens showing positive traction at 90 days:

• 45% were potential modifications
• 20% were full payoffs
• 11% were discounted payoffs
• 23% were executed modification agreements

This breakdown illustrates why diversification across resolution strategies matters. No single exit dominates. The note investor who can execute modifications, negotiate payoffs, and manage discounted settlements will capture the full spectrum of value in a portfolio.

What Can You Learn from a Non-Performing Second Lien Modification?

A non-performing second lien secured by a single-family residential property tells one of the most common stories in note investing.

Deal Setup

The property had a fair market value of $262,570 with a senior lien balance of $108,513, leaving $154,057 in equity above the junior lien. The junior lien carried a $29,000 unpaid principal balance and was acquired for $8,800 -- roughly 30% of UPB.

What Happened

The borrower had actually been paying the bank before the loan was sold. They had defaulted, the loan was charged off, but they continued making roughly $500/month payments through an undocumented, ad hoc arrangement. The bank had no formal modification in place -- a common situation with charged-off institutional loans where the borrower wants to pay but has no documented path to do so.

When the new investor acquired the loan, three questions framed the conversation:

1. What happened? -- The borrower fell behind but resumed informal payments
2. Where are you now? -- Paying but without documentation or a clear path forward
3. What do you want to do? -- Start a formal modification at roughly $540/month with no down payment

A modification agreement was executed at an 8.75% interest rate. After 12 months of seasoning -- consistent payments that demonstrate the borrower's commitment -- the re-performing loan was sold.

The Numbers

The investor who bought this re-performing loan locked in a 24% annual cash-on-cash return -- significantly above the prevailing market for re-performing note sales. The original investor who did the workout earned a 157% IRR in just over a year.

Takeaways

Charged-off borrowers who want to pay are the lowest-hanging fruit. These borrowers do not need convincing. They need documentation. A formal loan modification gives them clarity on repayment terms, helps their credit profile, and transforms a non-performing asset into a cash-flowing one.

Keep detailed notes on every borrower. When it comes time to sell re-performing loans, your ability to explain a borrower's story -- their payment consistency, their motivation, whether they are on an ACH plan -- directly affects the premium you can command.

What Does a Discounted Payoff Look Like on Vacant Land?

The second case study is a non-performing first lien secured by vacant land -- a completely different collateral type, lien position, and resolution method.

Deal Setup

The property carried an estimated fair market value of $33,000, but actual comps later revealed the value was closer to $18,000. The borrower owed $31,000 in principal balance plus $28,000 in combined HOA and tax liens. The loan was acquired for $3,150 -- roughly 10% of UPB.

What Happened

The borrower had fallen behind on taxes, HOA dues, and the mortgage simultaneously. They had limited income. On paper, this looked like a candidate for strategic default -- the borrower owed far more than the property was worth.

But the borrower responded to an options letter offering an $11,000 discounted payoff paired with a supportive letter to the credit bureaus. They counter-offered at $7,500. After negotiation -- including the borrower providing recently sold comparable sales proving the lot was worth less than originally estimated -- both sides agreed to $10,000.

The Numbers

Takeaways

Non-monetary incentives can unlock deals. The supportive letter to the credit bureaus was as important to this borrower as the dollar amount of the settlement. A charged-off trade line can damage a credit report for up to seven years. Offering to help clear that mark gave the borrower a tangible reason to settle -- even when the raw numbers did not justify it financially.

Underwater borrowers are not automatic strategic defaulters. This borrower owed more than the property was worth and still chose to pay. They wanted to keep the lot in their family, protect their credit, and avoid the risk of a deficiency judgment on the remaining balance. Emotional and practical considerations often override pure financial calculation.

The highest returns often come from the roughest-looking loans. A vacant land first lien with negative equity and a limited-income borrower does not look attractive on a data tape. But the acquisition cost was so low -- $3,150 -- that even a modest resolution produced a 217% IRR. Including a few of these higher-risk, higher-reward assets in a diversified portfolio can significantly boost overall returns.

How Should You Position Yourself Going Forward?

The note market rewards preparation. When supply increases and pricing compresses, the investors who have already built their systems, established servicer relationships, and developed resolution skills are the ones who capture the opportunity. Waiting until the pipeline opens to start learning means you are already behind.

Here is where to focus:

• Monitor the macro environment. Track regulatory changes, accounting relief expirations, and bank earnings calls for signals about upcoming portfolio sales. The supply pipeline telegraphs its movements months in advance
• Build your due diligence waterfall. Systematize the process of evaluating loans -- from secured vs. unsecured screening through collateral valuation, bankruptcy research, occupancy checks, and title review. Every step that you can make repeatable saves you time and money on the next acquisition
• Diversify across lien positions and collateral types. Senior liens resolve through the property. Junior liens resolve through the borrower. Vacant land, single-family residential, and other collateral types each carry different risk profiles and return potential. A mixed portfolio smooths out volatility and captures a wider range of outcomes
• Master the three questions. Every borrower conversation starts with: What happened? Where are you now? What do you want to do? These questions frame a cooperative dialogue that leads to resolutions -- not confrontations
• Keep workout timelines short. The faster you resolve a non-performing loan and recycle capital into the next acquisition, the higher your annualized returns and the less exposure you carry to market shifts

The secondary mortgage market does not reward passive observation. It rewards investors who build the skills to evaluate, acquire, and resolve distressed debt efficiently -- and who are ready to act when the next wave of inventory arrives.