For most private mortgage notes, the loan repayment schedule will have principal payments, but also interest payments, along with monthly instalments and fixed/adjustable terms. Every payment lowers the outstanding balance, but it also compensates the lender via interest income. It’s a steady source of income since you’re getting monthly interest.
When it comes to the interest rates, a lot of the time, these private mortgage notes will carry a higher interest rate. That’s because the lender is assuming a larger degree of risk when compared to a bank. Most of the time, these interest rates will depend on the borrower’s credit quality, property type, loan duration or market condition. But overall, it’s normal to see rates ranging from 6% up to 12%.
Sometimes, private mortgage notes will also need loan servicing. That means a professional loan servicer will be hired to manage payment collection, balance tracking, managing escrow accounts, monitoring taxes and insurance, etc. Also, in some cases, private mortgage notes can include balloon payments, which means payments are calculated over a long amortization period, and the remaining balance becomes due after a certain timeframe.
Types of Private Mortgage Notes
One of the things to keep in mind about private mortgage notes is that there are different types to consider. Each one has its benefits, so it can be a very good idea to consider each one’s pros and cons, then narrow down what works for you.
- Performing notes usually involve borrowers who make payments on time. These are ideal because they offer a stable income and a predictable cash flow, along with a much lower foreclosure risk.
- Non-performing notes involve borrowers who stopped making payments. They can be an option because you usually acquire them at a lower price. However, they might require loan modifications, foreclosure proceedings, borrower negotiations and so on.
- First position notes are holding the primary lien on the property. If a foreclosure occurs, the first lien holders get paid before everyone else. These notes are known for being a solid, powerful investment, so that’s certainly an option to keep in mind.
- Second-position notes are subordinate to the first-position notes. They have a higher risk, since the first-position lenders have repayment priority. But there is an upside, because a lot of the time, second position notes will have a higher yield.
- Seller-financed notes are made when the property sellers offer financing to the buyers. There are flexible terms, a faster closing system, an expanded buyer pool and ongoing passive income.
- Lastly, we have the commercial mortgage notes. These involve income-generating properties like office buildings, industrial facilities, apartment complexes or retail centers. They involve a larger balance and more complex structures. However, the ROI can be just as impressive.