You can lose money on a note. The payer can stop paying, the property can be worth less than you thought, a document can fail, and you cannot sell quickly at a quoted price. Careful checking lowers each of these risks and removes none of them.
Each risk is set out below with how it shows up and what a buyer can do about it, before closing and after, in more detail than the short list in the guide for note investors.
The payer stops paying
This is the central risk. A note is only as good as one household’s or one business’s ability and willingness to pay. People lose jobs, get sick, divorce and die, and none of that shows in a file on the day you buy.
From the first missed payment, what happens if the borrower stops paying is a sequence of reminders, an attempt at a workout and, at the far end, enforcement. Your income has stopped and your costs are running for all of it.
You lower this risk by buying notes with a long payment record that has been independently documented, a real down payment, and a payment the payer can plainly afford. Equity, the owner’s share of the property’s value after the debts against it, matters most of all. A payer with a lot to lose has every reason to find the payment, or to sell the property and pay you off.
The property and the lien
The property is not worth what you thought
The property is your fallback. If its value was overstated, or has fallen, or the building has been neglected, the fallback is smaller than your price assumed. Values also move with the local market after you buy, and you have no control over that.
Some property is simply harder to turn into cash. Vacant land, mobile homes, rural parcels and single-purpose commercial buildings have fewer buyers, so a forced sale takes longer and brings less.
The protection is your own independent valuation, recent photos, and a purchase price far enough below the property’s value that you have room to be wrong.
Something ranks ahead of you
Your lien, the claim on the property that secures the note, has a place in line. Unpaid property taxes generally come first whatever your position. If you hold a second lien, the first mortgage comes ahead of you too, and a foreclosure by that first lender can wipe your lien out. In some states, association dues and certain other charges can also take priority over a mortgage.
A title search before funding tells you where you stand, title insurance covers some of what a search can miss where you can get it, and a yearly check on the property taxes keeps a new claim from growing ahead of you. For the difference position makes, see first liens vs second liens for investors.
The paperwork fails
Your right to collect rests on documents, and a flaw in them stays quiet until the day you need to enforce.
- The original note is missing.
- The chain of endorsements or assignments has a gap, so the record does not show how the loan reached you.
- The mortgage or deed of trust was never recorded, or describes the wrong parcel.
- The documents were written without a lawyer and leave out terms a court would expect.
- The loan was made in a way that broke lending rules, which may hand the payer a defense.
Have an attorney review the full collateral file, meaning the set of loan documents, against the due diligence checklist, and get the seller’s written representations in the purchase agreement.
Time: enforcement and exit
Enforcement is slow and costly
Whether and how you can foreclose as the owner of a note is set by the state where the property sits. Some states route it through the courts and some do not. The time and cost differ widely, and the payer may have rights to catch up or to reclaim the property. A bankruptcy filing generally halts collection until the court allows it to continue.
All the while you earn nothing and you may be paying taxes, insurance and legal fees.
Preparation is the only defense: learn the state’s process before you buy, have an attorney there, hold a cash reserve, and pay a price that assumes the slow route.
You cannot get out quickly
Private notes have no exchange. To get your money back early, you find a buyer, they do their own due diligence, and they pay a price that gives them the return they want on their money. That takes time. If your note’s rate is below the return buyers want when you sell, the price will be below your balance, and the wider that gap the larger the discount.
So use only money you will not need. A clean servicing record helps as well, because a well-documented note is easier to resell.
Rules, fraud and concentration
The rules apply to you
Owning and collecting on loans is regulated. Depending on the state and the kind of loan, there can be rules on registration or licensing, on how payers are contacted and on what notices they must get. Which of them apply to you is a question for an attorney in the property’s state, and it is worth asking before your first purchase.
The other side is not honest
The frauds in this business are simple ones. Someone sells a note they do not own, sells the same note twice, alters a payment history or invents a property value. The defenses are equally simple: verify the seller’s identity and ownership, check the public record yourself, and release funds only through a closing agent you have chosen or checked, against delivery of the original documents.
Be as wary of promises as of documents. Anyone who quotes you a return on notes as though it were certain is selling something.
Too much in one place
One note is one payer and one property. If either fails, your whole position is affected. A buyer with five notes in the same town, or with the same kind of payer, has also concentrated more than the count suggests.
Smaller positions in different locations spread the exposure. So do partials, where you buy a set number of a note’s payments for a smaller price, which lets the same money sit behind more than one note.
Risk and response at a glance
| Risk | Check before you buy | Habit after you buy |
|---|---|---|
| Default | Verified payment history, equity | Act on the first late payment |
| Property value | Independent valuation, photos | Recheck value and condition from time to time |
| Lien priority | Title search | Confirm property taxes are paid each year |
| Paperwork | Attorney review of the file | Store the originals securely |
| Enforcement | Learn the state’s process | Keep a cash reserve |
| Liquidity | Invest only long-term money | Keep an independent servicing record |
| Fraud | Verify seller and ownership | Fund only through a closing agent |
Go through the table with one real note in front of you and mark which rows you could check yourself and which need a professional. Each note we send to people who join the buyer list is marked with what has been verified and what has not, so the open rows are visible before you spend money on due diligence.
What is left after all the checks
Do everything on that table and a note can still go wrong. A payer with ten clean years can default in the eleventh. A sound property can be damaged. That remaining risk is what the discount pays you for, and it is why the right price is one you could live with on a bad day.
If that seems like more uncertainty than you want, it may be. Deciding against notes is a reasonable outcome of reading this page.
Related questions
Can I lose my whole investment in a note?
Yes, it is possible. It is most likely where the lien is in second position, the property is worth little, or the documents cannot be enforced. A first lien bought well below the property's value makes a total loss less likely, though it does not rule it out.
Is a note secured by real estate a low-risk investment?
It is a secured investment, which is not the same as low risk. The security only helps if the property is worth enough, your lien is valid and in the position you believe, and you can afford the time and cost of enforcing it.
Does buying through a broker remove the need for my own checks?
No. A broker can gather the file and tell you what has been verified, which saves you time. The money at risk is yours, so the title search, the valuation and the document review should still be done for you and reviewed by you.