Check out this video where I discuss the 3 types of mortgages and the expected returns based on performance. The 3 types are institutional mortgages, private lending mortgages and seller finance mortgages.
INSTITUTIONAL MORTGAGE NOTES (see chart below)
So first of all we're going to talk about what I call institutional mortgage notes that are originated from the big institutions like the Wells Fargo, Bank of America, Chase, etc. These types of institutions generated many of the notes that became non-performing after the crash of 2008. But first lets talk about performing institutional notes. These are ones performing for several years and the default rate is very small…less than 1%. This is high quality paper that is typically held by a moneycenter banks such as Bank of America or a Chase. There is usually very little discount when banks sell these notes and are usually bundled into MBS (mortgage backed securities) and sold. There is not much upside and the yields are low so we don’t get involved in this arena.
The next category is re-performing mortgage notes. A re-performing note happens when a homeowner stops paying for several months or even years and then something occurs and they get on track with their payments. That could be a reinstatement or they got a loan modification or some workout. Typical returns are in the ball park of 8-12% but change wildly with the conditions of the housing market. Now if I bought the note in default (non-performing loan) and I got it re-performing by doing a loan modification then my returns would be much higher (15-25%) depending on the note discount price. I consider a re-performing note as one that has been paying for at least 12 months after it became re-performing. Remember these long term notes give you cash flow and payments not for months but for years…up to 30 years.
The next category is sub-performing mortgage notes. These are notes where the borrower pays but not consistently. The borrower pays for awhile and then suddenly stop paying for a period and then maybe catches up the back payment to become current again. Many stops and starts. You can buy these at a bigger discount but these sub-performing mortgage notes requires more management since you have to stay on top of the borrower to make payments. In other words, you have to babysit or what I call ”adult daycare”. The returns are higher since higher risk. The exact returns vary dramatically but usually between 10-15% but I have gotten much higher on some because I was able to get a good discount on price.
The next category is non-performing mortgage notes. These are notes that are not paying and could be a few months to multiple years behind on payments. I have purchased notes that had not paid in 7 years. These are ones for the experienced note investors and not a place to start. The note discounts for these types are in the range of 25-50% of UPB (unpaid principal balance) as long as the property value supports the price. In general, I am looking to pay up to around 65% of value and up to 75% of UPB. The target yield varies dramatically but typically are 20-50%. I have many notes that make a lot more than 50% but the returns are many times determined by the overall market conditions.
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PRIVATE MORTGAGE NOTES
Here I have lumped together private lending mortgage notes and seller finance mortgage notes. The seller carry back note is when a seller acts as the bank or lender and carries a mortgage on their property. Private lending or hard money lending usually involves an individual or some entity loaning money to someone for a fix and flip, fix to rent, buy to rent or some type of bridge financing.
SELLER/OWNER FINANCING
When a seller acts as the bank or lender and carries a mortgage on the subject property.
RATES - 7-12%. Depends on amount down, note position, borrower credit, loan to value, etc.
Buy these notes at a discount and get an even better return.
PRIVATE LENDING/HARD MONEY LENDING
Fix and Flip financing
Fix to Rent financing
Buy to Rent financing
Refinance and Bridge financing
RATES - 10-18% plus points
I love to buy these notes at a discount which allows me to get a better return. For example, if there was a 20 year note at $100,000 at 7% and you got a discount on the note where you bought it at 80,000 (i.e. 20% discount) your returns go up from 7% to 10%. The other benefit with private lending is you can charge points (1 pt equals 1%) as a fee for doing the transaction. The amount of points a lender charges varies but typically in the range of 2-4 points depending on the credit, experience, collateral, etc.
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