Key Takeaways
- A partial note purchase is a type of real estate investment that entitles you to part of the payments made on a mortgage note.
- You can purchase as much or as little of a mortgage note as you need.
- The portion of mortgage payments you receive depends on how much of the note you own. For example, owning 50% of the note entitles you to 50% of the payments.
- Partial notes allow you to invest at a lower cost and with less risk than investing in full mortgage notes. However, you won’t get as much profit if the note performs well.
- You can sell your partial mortgage note at any time with help from your lawyer. You’ll get cash for its value but will give up the right to collect any future payments from it.
How Does a Partial Note Purchase Work?
By investing in someone’s mortgage note, you gain the right to collect a portion of the payments made on the mortgage loan. How much you receive depends on the percentage you own of the note you invested in.
For example, an investor might own a mortgage note worth $50,000 scheduled to be paid off in $1,000 payments over the next 50 months. If you purchased 50% of the note, you would be entitled to half of those $1,000 payments — $500 for 50 months — for a total of $25,000.
To make a partial note purchase, you’ll need to:
- Identify a suitable note. Look for local mortgage loan companies or private investors who might have one for sale.
- Negotiate terms of the sale. Decide on a mutually acceptable price for your partial note and figure out how much of the note that price will get you.
- Draft a contract. Have a lawyer lay out the terms of your sale agreement in writing, and then sign the contract along with your seller.
- Fund the investment. Pay the agreed-upon price and take possession of your partial note.
- Start receiving payments. You’ll receive the amount stipulated in your contract until the mortgage loan is paid in full.
Pros and Cons of Partial Note Purchases
Not all mortgage note buyers purchase partial notes.
Some benefits of buying a partial note include:
- Lower investment costs. Instead of paying the full purchase price of a mortgage note, you can invest as much or as little as you want.
- Greater potential for diversification. Buying partial notes frees up more of your investment budget to purchase other assets and further diversify your portfolio.
- Greater flexibility. You can tailor the size of your mortgage note investment to suit your needs and risk tolerance.
- A chance for higher returns. Buying multiple partial notes gives you more chances to secure a share of a high-performing note. Some mortgage notes generate an exceptional return in investment.
- A steady income stream. You’ll have the right to collect a percentage of the payments made toward the mortgage note for as long as your contract allows.
- Limited liability. Because you only own part of the mortgage note, you won’t lose as much equity if the borrower defaults on the loan.
This investment option also presents risks and drawbacks, including:
- Limited control. Because you don’t own the entire mortgage note, you don’t have full control over the payment collection or foreclosure processes.
- Limited profit potential. If your investment pays off, your profits won’t be as large as they would be if you purchased the full note.
- Potential losses. If the borrower defaults on the mortgage, you may have to sell the property at a loss during foreclosure.
- Limited liquidity. You could have a hard time finding a buyer for your partial note if you want to divest.
- Complex legal considerations. You’ll need a lawyer’s help to negotiate the terms of the sale and draft the sale contract.
Partial mortgage note sales also benefit sellers, who can convert a portion of their note into cash, allowing them to reinvest that money into other ventures while retaining some of their initial investment. However, this also reduces their control over the foreclosure process and forces them to split payments with the buyer of the partial note.
Who Owns the Note When Part of It Is Sold?
If you sell part of a mortgage note, you retain ownership of the rest of it, giving you fractional ownership.
The size of each party’s share depends on the terms of the original purchase agreement. The contract will specify the percentage of the note that you and the partial holder own as well as the rights and responsibilities you each have.
Each party has a right to collect partial payments based on their percentage of ownership. Owners also have the right to collect a portion of the proceeds if the home or property is sold during foreclosure.
Each party is responsible for collecting their portion of the payments from the mortgage holder. Parties must also agree on how to make decisions about the property, such as whether and when to initiate a foreclosure.
When Is a Partial Note Purchase the Right Idea?
Partial note purchases work well for investors with tight budgets. They’re flexible and let you customize your real estate investment portfolio the same way you would a stock portfolio.
Consider purchasing a partial mortgage note if you:
- Don’t have enough investment funds to buy a full mortgage note
- Want to diversify your portfolio and spread out your risk
- Are just starting in mortgage note investing
Remember that partial mortgage notes are an asset and a source of income. If you decide that partial note investing isn’t for you, selling your payments is always an option. You can then use the proceeds to invest in something else.
