Note Investing Today

Not all mortgage notes are the same. The secondary market offers a wide range of asset types, and your success depends on choosing the right niche for your capital, time, and risk tolerance. This lesson breaks down the four criteria that define every note on the market and helps you identify which strategy fits your situation.

The Four Criteria That Define Every Note

Every mortgage note you encounter can be classified along four dimensions. Understanding these dimensions is how you filter a universe of thousands of assets down to the ones that match your investment thesis.

1. Performance Status: Performing vs. Non-Performing

This is the most fundamental distinction in note investing.

Performing loans are cash-flowing assets. The borrower is making monthly payments as agreed. When you buy a performing note, you are buying a stream of income -- similar to buying a rental property that already has a paying tenant. Returns on performing notes typically range from 7.5% to 20% annually, depending on lien position and risk profile.

If you have more money than time, start with performing notes. They require less active management. You buy the loan, board it with your servicer, and collect monthly payments. The due diligence is still important, but the ongoing resolution work is minimal.

Non-performing loans (NPLs) are defaulted assets where the borrower has stopped making payments. These are the "fix and flip" of note investing. You buy the broken loan at a steep discount, work with the borrower to resolve it, and either hold the re-performing asset for cash flow or sell it to a passive investor. NPLs require more time and expertise, but they offer significantly higher returns -- often 20% to 50%+ IRR when resolutions go well.

Re-performing loans (RPLs) sit in between. These are loans that were once non-performing and have been rehabilitated -- an investor worked with the borrower to get them back on track. RPLs trade at a premium to NPLs but a discount to never-defaulted performing loans, because there is always some re-default risk. RPLs are an excellent entry point for investors who want cash flow with slightly higher yields than traditional performing notes.

2. Lien Position: First vs. Second

Your note's position on the property title determines your risk profile, your pricing, and your resolution strategies.

First liens (senior debt) are the primary mortgages on a property. As the first-position lien holder, you have priority in repayment -- you get paid before any junior lien holders. If the borrower defaults and you foreclose, you recover from the property's sale proceeds first.

• Pricing: NPL first liens are priced as a percentage of the property's fair market value (FMV), typically 8% to 83% of FMV
• Resolutions: More property-centric. First lien investors are more likely to end up taking back properties through foreclosure or deed in lieu
• Capital requirements: Higher. First liens are larger dollar amounts per asset
• Due diligence: More expensive ($250 to $500+ per asset for title, BPO, and related costs)

Second liens (junior debt) are subordinate mortgages -- HELOCs, second mortgages, or home equity loans. As the junior lien holder, you are behind the first mortgage in repayment priority. If the first lien forecloses, the second lien can be wiped out entirely.

• Pricing: NPL second liens are priced as a percentage of the unpaid principal balance (UPB), typically 5% to 65% of UPB
• Resolutions: More borrower-centric. The borrower is usually still paying their first mortgage, which means they want to stay in the home. That emotional equity creates leverage for modifications and payoffs
• Capital requirements: Lower. Second liens have smaller balances, allowing greater diversification
• Due diligence: Less expensive ($50 to $200 per asset), though credit report analysis of the senior lien status is critical

Many experienced investors prefer second liens. They offer greater diversification, lower capital requirements, more borrower-centric resolutions (which means fewer REO situations), and higher potential returns. The trade-off is the risk of being wiped out by a senior lien foreclosure -- which is why checking the senior lien status via credit report is the single most important piece of due diligence for a second lien investor.

3. Geography: Judicial vs. Non-Judicial States

The state where the property is located determines how foreclosure works, which directly affects your timeline and costs if you need to enforce your lien.

Judicial foreclosure states require the lender to go through the court system. This process can take 1 to 3+ years and involves attorney fees, court filings, and potential delays from borrower defenses. States like New York, New Jersey, Florida, and Illinois are judicial states.

Non-judicial foreclosure states allow foreclosure through a trustee process without court involvement. This is significantly faster (often 3 to 6 months) and less expensive. States like Texas, Georgia, California, and Arizona are non-judicial states.

Your geographic strategy also involves a choice between:

• Local investing -- Buying notes in your home state or region, where you know the market and can visit properties if needed
• Nationwide investing -- Buying notes across the country to access a larger pool of deals and diversify geographic risk

Most note investors -- especially those focused on second liens and borrower-centric resolutions -- invest nationwide. The work is done over the phone and on the computer. You do not need to visit the properties. If your strategy involves taking back properties (REO), a more localized approach may be practical.

4. Property Type

The type of real estate securing the note affects valuation, borrower behavior, and exit strategies:

For most note investors starting out, single-family residential is the clearest path. The valuations are straightforward, the borrower motivations are understandable (they want to keep their home), and the exit options are the most numerous.

Strategy Comparison: Notes vs. Physical Real Estate

If you are coming from traditional real estate investing, this comparison helps frame where note investing fits:

The key insight: Note investing is overwhelmingly laptop-and-phone work. You are analyzing spreadsheets, reviewing reports, making calls, and managing relationships with servicers and attorneys. It is far less time-intensive than physical real estate, and it is entirely location-independent. You can run a note investing business from anywhere with an internet connection.

Choosing Your Starting Point

There is no single correct strategy. The right choice depends on your personal situation:

• More capital, less time? Start with performing notes. Buy cash-flowing RPLs, board them with a servicer, and collect monthly payments.
• Less capital, more time? Start with non-performing second liens. They require more active work but offer higher returns on smaller investments.
• Want maximum diversification? Second liens allow you to spread your capital across more assets at lower price points.
• Want tangible collateral control? First liens give you more direct access to the underlying property, though you will deal with REO situations more frequently.
• Local market expert? Consider first liens in your area where you can leverage your property knowledge.
• Want to invest nationwide? Second liens with borrower-centric resolutions work well regardless of geographic distance.

The beauty of note investing is that your strategy can evolve. Many investors start with a handful of NPL second liens to learn the resolution process, then expand into performing notes for passive income, and eventually build a diversified portfolio across lien positions and performance statuses.

The next lesson covers the practical step that comes before your first deal: setting up your business entity, choosing your tools, and laying the operational foundation for your note investing company.