Performing, unless you already work with distressed property. A performing note, one where the payer is paying on time, lets you learn how ownership works while the income arrives as planned. A non-performing note hands you a problem to solve on your first purchase, with legal costs to carry and no income while you solve it.
A payment stream or a situation
A performing note is a payment stream. The work is in checking the file before you buy and reading the servicer’s statement each month afterward.
A non-performing note is a situation. The payer has stopped, the price is lower because someone has to deal with that, and your result depends on what you do next: a new payment plan, a settlement, taking the property back, or selling the note on.
| Performing | Non-performing | |
|---|---|---|
| What you rely on | The payer continuing to pay | Your plan, and the property’s value |
| Income after closing | Starts with the next payment | None until the problem is resolved |
| Price compared with balance | Smaller discount | Larger discount |
| Money needed after purchase | Servicing fees and a reserve | Legal fees, taxes, insurance and possibly repairs |
| Your time | Light, once the note is boarded with a servicer | Active, sometimes for a long stretch |
| Knowledge needed | Pricing and due diligence | The same, plus default law in that state |
| Range of outcomes | Narrow | Wide, in both directions |
One variable at a time
A first note teaches the routine: reading a note and a security instrument, ordering title, confirming a balance, closing, handing the loan to a servicer and keeping records. Every later purchase uses the same routine.
On a performing note you learn it with one thing uncertain. If the payer keeps paying, your result is the yield you priced, and you can check your own arithmetic against what happens.
On a non-performing note you learn the same routine while also running a workout or a foreclosure, possibly in a state whose rules you have never read, with costs that are hard to estimate ahead of time. If it goes poorly, you will struggle to tell whether the pricing, the plan or plain luck was at fault.
What the bigger discount pays for
Non-performing notes sell for less because buyers subtract the cost, the delay and the uncertainty of resolving them. The discount is payment for work and risk, and each of those deductions is difficult to size without having been through a default before. A low price on a note in an unfamiliar state, or on a property in poor condition, can still be too high.
Before you bid on one, go down the exit strategies for non-performing notes and try to put a cost and a delay beside each. If you cannot, you would be taking one of the risks of note investing with no way to measure it.
When non-performing can be a reasonable start
The case for starting with a non-performing note gets stronger with each of these that applies to you.
- You already work with distressed property, as an investor, agent, contractor or attorney.
- You know the local market and would be content to own that property.
- You have an attorney in that state lined up before you bid.
- You have cash set aside beyond the price, and you do not need income from it soon.
- You are buying with an experienced partner who has done it before.
If several of these fit, tell us when you join the buyer list that you want to see non-performing notes. If few do, ask for performing ones.
Performing notes default too
A note that is performing today can stop tomorrow, since any payer can lose a job or fall ill. Choose a first note on which a default would be manageable: a first lien, real equity in the property, a payer with a long record, and a state where you could find help. Read what happens if the borrower stops paying while you are still deciding, so the options are familiar before you need them.
Picking the first one
Someone starting out can narrow the search to performing first liens, and to partials if a whole note is a bigger check than you want to write. From there, follow the plan in buying your first note, which is one part of the wider investor guide.
If the table above left you undecided, work through the fuller comparison of performing and non-performing notes for investors with one question in mind: which column describes a year you could live with if it went badly.
Related questions
Are non-performing notes more profitable than performing notes?
They are priced lower because they need work, money and time to resolve, and the outcome is uncertain. Some turn out well and some badly. Nobody can tell you in advance which a given note will be.
What is a re-performing note?
It is a note that fell behind and has since returned to regular payments, often after the terms were changed. Buyers look at how long the new run of payments has lasted before treating it like a performing note.
Can I buy a performing note and never deal with a default?
You might, but do not plan on it. Any payer's circumstances can change. Choose a note where a default would be manageable and know your options before you buy.