A note is a signed document between two parties acknowledging a debt and promising repayment. Simply put it is a promise to pay.
Bob borrows $10,000 from Paul to buy a house and signs a note for $10,000 agreeing to repay the debt in one year with 6% interest.
A note can be secured by real estate. This allows the lender to sell the property if the borrower does not faithfully repay the debt as agreed in the note.
In many states a mortgage is used to secure a note with real estate. In California the most popular means of securing a note with real estate is a trust deed or deed of trust.
Many notes are originated when a piece of real estate is sold. If the buyer is unable to procure financing to buy the property outright, the seller may “carry back” a note secured by a deed of trust.
For instance, Bob is buying a house from Paul for $100,000. Bob has $15,000 cash and is able to get a bank loan for $75,000. This leaves him short of the purchase price by $10,000. Paul can take a note from Bob promising to pay $10,000 if Bob is willing to pay interest on the $10,000 and repay the balance in 5 years. Both parties win. Paul is able to sell the house and Bob is able to buy the house.
Notes as Investments
A note is similar in concept to annuity. The investor makes an initial investment, the loan. If all goes according to plan, the investor receives steady payments from the borrower until the debt is repaid.
Notes are generally good investments for those that have reached their retirement years. Notes offer income to the investor that can be used to fund monthly expenses.
Real Estate Note Variety
Real estate notes come in all sizes and shapes. Notes can be secured by homes, office buildings, shopping centers, apartments, vacant land, or warehouses. Notes can range in value from a few thousand dollars to millions of dollars.
Notes are often sold when the original lender needs a lump sum, rather than income.
For instance, Paul needs to pay his daughter’s college tuition of $7,500. The $50 of monthly interest is not sufficient to pay the tuition and he requires a lump sum.
Paul could sell his note to an investor. If the investor pays the face value on the note, $10,000, the investor will receive a 6% return on their money until the note is repaid.
If an note holder is willing to accept less than the face value of the note, this note is said to be discounted. The note buyer will be able to realize a return greater than the stated rate.
For instance, Paul loans Bob $10,000 for one year at 6% interest due at the end of the year. That same day Paul sells the note to Jim for $9,500. Jim will earn a return of 11.58% on his investment of $9,500.
For the savvy investor, buying notes at a discount can be a great means of earning above average returns.