Note Brokering &
Investing Academy
Module 1 · Note Basics

A Simple, Passive Investment Strategy with Performing Notes

What to check before buying a performing note, plus a real Pennsylvania case study with its balance, ITV and yield.

5 min read · Lesson 1.3

At first, investing in notes may sound complicated. In reality, if you do your due diligence correctly, a performing note can be one of the simplest and most passive forms of real estate investing. It provides steady monthly cash flow without the hassles that come with tenants.

What you see in a performing note

A performing note is simply a mortgage where the borrower pays consistently every month. When you buy the note, you look through the collateral file. You should be able to see:

  • Unpaid balance (UPB): the amount left on the loan.
  • Term: the number of remaining payments.
  • Interest rate: the interest charged on the borrowed money. Investors typically buy notes at a discount, which raises the investor’s yield above the note’s interest rate.
  • Monthly payment: the principal and interest payments the investor collects.
  • Pay history: a record of how much was paid and when.

Due diligence questions for a performing note

If a note is performing, the borrower is paying on time and in full. Sounds like you’re ready to go, right? Wrong. You still need to find out how long that borrower has been making those payments. For a performing note, ask:

  • How long is the borrower’s pay history? A third-party statement is better than information straight from the note seller, who could alter the history to make the note look more attractive.
  • Does the borrower pay on time? Late payments often mean the note is less likely to keep performing.
  • What is the current condition of the property? Work with a local real estate agent to get the fair market value of the property in its as-is condition. If you have to foreclose, you may have to take the property back and resell it.
  • Are all taxes paid? If not, the county could take the property.
  • What is in the collateral file? It should include the original promissory note and a mortgage or deed of trust, and it may show other transfers of ownership. Think of it as a vehicle history report for your note. If it is incomplete, find out why.
  • How does the payment compare with local rents? If the borrower would pay more to rent a comparable home, they are more likely to stay and keep paying.

Equity, ITV and early payoffs

Those six points are a good start, but weigh two more factors before you buy a performing note.

First, if the borrower has equity, they are more likely to keep paying, and you have a better margin of safety if they default later. Find that margin by comparing your purchase price with the fair market value of the house. Most note investors look for an investment-to-value (ITV) ratio of 80% or less.

Second, compare the cost of the note with the unpaid balance. If the note pays off early, you get the full payoff, which usually increases your return. If it doesn’t, think carefully before you buy.

Worked example: a performing note in Pennsylvania

Here is a performing note the author bought in Pennsylvania:

ItemFigure
Unpaid balance$32,167.33
Payments remaining138
Fair market value$47,000
Monthly payment (principal and interest received)$375
ITV48.2%
Yield13.2%

The note pays consistently. The author has never had to visit the property or deal directly with the borrower, and simply receives a payment every month.

Low ITV, steady payments, no tenant calls.

Drawbacks to weigh before you buy

No investment is perfect. Consider these points before buying a performing note:

  • Performing notes tend to be expensive. One alternative is to buy non-performing notes at a discount and work with the borrower to make the note perform again. Another is to create your own notes by selling properties you own with seller financing.
  • Notes must be serviced for good record keeping and to collect your payments. At the time of writing (2020), servicers typically charged $20 to $30 a month. Don’t service a note yourself unless you understand and can handle the accounting, borrower communications and reporting needed to keep everything legal.
  • Even performing notes can default. The risk never goes away completely.
  • There may be fewer tax benefits. Note investing is often compared to being a landlord, but it does not carry the same tax benefits as rental property.

In the end, it comes down to your goals and circumstances. A performing note can add good diversification and a solid passive investment to your portfolio.

Key takeaways

  • Verify pay history with a third party
  • Check taxes, value and collateral file
  • Aim for an ITV of 80% or less
  • Budget for a professional servicer

Try it yourself

A house securing a first lien note is worth $47,000. What is the most you could pay for the note and still meet the 80% ITV guideline?

Show answer

$37,600. Multiply the $47,000 value by 80%. Any price at or below $37,600 keeps your ITV at 80% or less.

Keep going

More in Note Basics

Learn the full method, step by step.

Start the Course

No hype. No income claims. Just the real numbers.

Start the Course Curriculum