Real estate investing goes way beyond buying properties. You could always generate passive income through note investing. In this episode, Chris Seveney breaks down how exactly note investing works, the difference between performing and non-performing notes, and why it is a more affordable and hands-off way to grow your wealth. He shares valuable insights on managing risk, working with loan servicers, and maximizing returns without the headaches of property ownership. Whether you are new to note investing or looking for practical tips to refine your strategy, this episode has everything you need.

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5 Key Insights You Need To Know About Note Investing

Welcome everybody to another episode of the Creating Wealth Simplified. I’m excited to talk to you about five things you need to know about note investing for passive income. We will talk a little bit about what note investing is, and how notes can truly provide passive income to investors. I will differentiate the opportunities in note investing from performing and non-performing. We’ll talk about risk and due diligence, and we’ll talk about how it is more affordable than you think to get into note investing. Sit down, chill out, and let’s spend the next twenty minutes together talking about how note investing can be for you in passive investing.

First, let’s start with what note investing is. To boil it down very simply, it means that you are buying the loan or being the lender on a property instead of owning the property itself. I believe that is an avenue that people struggle with in understanding that you don’t own the property. You don’t have an equity stake in the property. You are just a lender. Think about if you’ve ever owned a home. Let’s use Bank of America as an example. If your loans are through Bank of America, they don’t deal with whether you rent it. They don’t deal with roof repairs or broken windows. As we like to say, no tenants, toilets, or termites. You are just the lender.

If you’ve ever tuned in to some episodes in the past, one thing you’ll know is I also harp on a lot that if you drive through any major city, who owns or has the name on that biggest building? Typically, it’s the bank. It was Rockefeller who said, “You want to own nothing, control everything.” How does it work? When you step in as a lender, you get a servicing company. I’m going to use a lot of references to owning property because that’s what people can relate to.

How Note Investing Provides Passive Income

A servicing company, which is the equivalent of the property manager, deals with the borrower, collects the payments, and does the tax forms. All of that is done by the servicer for between $25 and $50 a month. It’s very affordable within the loan industry to have somebody else handle that. The next step is, “How does it truly provide passive income?”

Those loan servicers handle that heavy lifting, and when you think about owning a mortgage, how often do you pay your mortgage? Similar to paying rent, once a month. The difference is when you own a property for a month, outlets could break, garbage disposals could get clogged, toilets could leak, showers could leak, and AC or heat may not work. You name it. It can go wrong in your home. It happens between the hours of Saturday and Sunday, between midnight and midnight. I don’t know why but it seems to happen at the least or most inconvenient time.

On a note, you don’t deal with that. The service will let you know if a payment was made or wasn’t made. They pick up the phone, call, and continue to see what’s going on. They send the statements, they keep you compliant, and they handle the majority of it, which then allows you on the performing side of things, a performing loan is when the borrower is making consistent payments, providing predictable income.

As I mentioned, I’m going to continue to harp upon this. You are not dealing with vacancies, maintenance calls, none of that. A lot of benefits to being more passive and owning a note than there are in traditional real estate. Let me dive a little bit deeper into note investing because hopefully, I piqued your interest and threw out some terms that people hear a lot. I will provide some additional definitions too.

You may hear about performing or non-performing loans. Performing is what you think it is. Borrowers make reliable payments, pay on time, and do not do any heavy lifting. They keep insurance and pay their taxes as part of the escrow. No issues on performing loans, and it provides consistent returns. Those returns will be lower compared to a non-performing loan, which has a higher upside because you are buying those loans at a bigger discount, but there’s a lot more work.

You can rely on the servicer to get the attorney and everything involved, but I’d recommend anybody who gets involved in this and becomes a master of the trade, to build those relationships and handle it yourself. The best reference for me would be buying a rental that needs to be fixed up, and you are going to manage the construction and renovation of the property. There’s a lot of upside to it and a lot of risk, but you get the reward.

When we talk about non-performing loans, let me define what I mean by that. Those are loans typically 90 to 120 days or more behind, 3 to 4 months behind not just a week, not missing a payment, but making it before late fees kick in. These are loans that are seriously delinquent. I will tell you that we buy loans that are typically 2 to 4 years behind, loans going from 90 to 120 or 6 months. That’s not uncommon.

Understanding First Position Versus Second Position Loans

I have gone and defined performing and non-performing. Let’s talk for a minute about the first position versus the second position. For those who own a home, the first position is typically your primary mortgage. The second position might be a line of credit, a HELOC. I view this as being in line, so I’ll share a story. When I was younger, in college, we used to get in line to get tickets to concerts. Back in the day, we went to see Pearl Jam. I’m aging myself and you’d be waiting in line to get tickets, but they sold out pretty quickly.

The first position means you are first in line. The second position means you are behind somebody, and in notes, you want to be in the first position. You want to be able to make sure you get that ticket. Second carries more risk than first, and I will explain why. Let’s say you have a property that is worth $300,000 and there’s a $200,000 first position on it. You, as the first position lienholder, are like, “This person sells this property or they default, it goes to auction. It’s worth around $300,000. I’m only owed $200,000. I’m getting paid, I’m cool.”

 

If you are in a second position and the borrower defaults, let’s say you have a $100,000 second position. They owe the first $200,000. They are like, “Okay, cool,” I’m getting paid, all of a sudden, but then realize, “Maybe I’m not, because is it worth $300,000?” Plus, you are not paying that $100,000 loan. What happens to that? Accrued interest, late fees, legal fees? That $200,000 loan, all of a sudden turns into $220,000 quickly. They don’t pay taxes, not paying insurance, and then you find out that it’s only worth $280,000.

The first position’s like, “I’m cool, I’m owed $220,000, it’s worth $280,000,” you are in second position. Now what happens? You know you are on a $100,000 loan. If $220,000 is going to the other person who sells for $220,000, you are only getting $60,000. Much bigger risk if they were to file bankruptcy. Sometimes bankruptcy gets completely wiped out.

I’m not going to go into too much detail on it here, but understand, that the lien position is extremely important for people getting started. I know a lot of people like that second position because it’s a lower barrier to entry. I’m a first-position guy. It’s who I am. I have done some second. One thing I want to mention about the different types of loans is typically most people view note investing as an income play. Meaning you are collecting those monthly payments.

It’s not growth like owning property where the equity is. Non-performing can give you that growth side because you are buying it at a discount to give you that equity. We talk about that more in other episodes, but I want to mention here that traditionally, it is more of an income play. If you do get into non-performing, it can be growth, but it’s extremely active in that scenario. It is not passive. You want to be passive, with strict income play and monthly payments coming in the door.

Let’s talk about number three, risk. Every investment strategy has significant risk. I love when I see posts on social media that say, “Give me $20,000. I will double your money in 30 days.” No risk is involved in that. Might as well go to the local casino, put it on red or black, and roll the dice. How do you assess risk in note investing? You want to be more passive. Think about when you applied, what did the bank look at? They looked at your creditworthiness. Do you pay your bills? What’s your credit score? They want equity. They want you to have some skin in the game, as they call it. They want that loan balance to be less than the property value because it gives you something that you could lose. You could lose that equity.

Those are major risk factors as part of note investing and things that you have to assess. What’s the biggest risk? Two things I always harp on are the unknown and time. What do you mean by that? The unknown is one of the downsides of being a lender you don’t know what the inside of most of these properties looks like. As a lender, if you own a house, you can’t come knocking on the door and say, “Let me see the inside of your house.” There’s a potential risk on the actual value of the property because you might think it’s worth $400,000, but the property’s destroyed or they ripped out bathrooms or kitchens, and now it’s only worth $250,000. That happens. That’s why it’s better to have a diverse portfolio.

The unknown is one of the downsides of being a lender. You do not know what the inside of most properties looks like. Share on X

There is time. “What do you mean when you say time?” Time is money. If the loan is not paid, you are missing out on payments every month. Foreclosure takes time if you have to go down that path, even if the property has equity when it’s sold at auction. I’m recording this in mid-January of 2025. I have had two properties that were sold at foreclosure auction, both to third parties, by the way. It’s not like we took them back.

Somebody bought it, gave the money to the court and the sheriffs, and took possession of the property. That was in July. Six months later, courts are still sitting on that money and haven’t released it. I can only imagine how many millions of dollars they sit on. Yes, that is something that frustrates me when people talk about attorneys, cities, jurisdictions, or permit offices. Wait until you have to deal with the court system. It’s mind-blowing. I’m not even going to get into too much detail because I don’t want to get caught up in the court system.

I will again reiterate that it’s been 6-plus months, 6 figures of money sitting in someone else’s bank account because paperwork hasn’t been processed. How do you reduce this risk? That is a great question. The time risk is having to focus on good attorneys who know what they are doing and respond quickly. There are certain things you cannot control. I can’t control the government, I can’t control the courts. Your servicers and your attorneys and managing them is the best way to reduce risk.

Talk about number four, which is getting into note investing. I have talked about this in the past and I continue to talk about it. You can get into note investing with $2,000, whether you are doing private lending, short-term for somebody, or a fund. You can start with $5,000. It could still be on $100,000. If you are going to do it yourself, it could still be on a $100,000, $200,000, $300,000 property. It’s a $20,000 or $30,000 loan.

Making Note Investing More Affordable Than You Think

That’s why people like seconds. In seconds, somebody might have a $20,000 loan on their property and can pick up that note for $15,000, maybe $16,000. It’s more affordable than buying property. Remember, when you start small, returns are not going to be great. What do I mean by that? If you are making 10% on $5,000, that’s $500 a year. Still good, but people go, “I’m only making $500.” What do you expect? I see people, for example, with $300,000 a year in their W-2 job and wanting to quit their job and sell a property that had $500,000 in equity. They wanted to know if that $500,000 in equity could be invested to replenish their $300,000 income.

Note investing is more affordable than buying property. Share on X

They were looking at a very large return. If you wanted a $300,000 or a $500,000 investment, that’s a 60% return. I don’t know how many people are going to get you a 60% return, especially at a low risk. I have seen funds out there that are offering 40% that have court cases on them. Now, they even have accounting software.

They did everything in Excel, but it’s math and understand, you are not going to get rich with a little bit of money in note investing. You are not going to get rich off of anything, and I know you can read online about somebody hitting it, or doing this, or buying some stock, or some meme coin, or whatever the case may be. It happens. Does it happen to everybody or most people? Nope.

Understand that it takes time to scale. If you become good at note investing, you get better at it and you understand it, then you can leverage that experience, invest in multiple notes, spread the risk, and eventually, start talking to people about maybe even having them fund some deals. It’s more affordable than you think, but just be realistic about the returns.

Let me jump into the last one that I want to talk about. It is often overlooked as a huge advantage to note investing compared to traditional real estate. I have mentioned this in the past and I will mention it again. Typically, in note investing, you don’t have any leverage, meaning you don’t have a loan. You are the bank. You don’t have a loan for that loan. That’s important to understand because if you go buy a rental property for $200,000, and you put $40,000 down and you are financed $160,000, the property goes down to $160,000 and you have no cash, you can’t sell it, or you are going to have to short sell it if the tenants aren’t going well or the money isn’t coming in the door.

Whatever happens, that can cause some illiquidity. You can sell it, but potentially, you might not be able to because the bank won’t let you. In notes, because it’s like a cash purchase, you can liquidate it anytime. You could take a loss, but it’s better to sometimes take a loss early than a loss late and lose more, but you don’t have to always take the loss. Besides selling the note, you can modify the terms with the borrower. If the borrower’s a spotty payer, modify it to get them on a new payment plan that can still be a win-win for you. That’s another option.

Myriad Of Exit Strategies In Note Investing

If they stop paying and you are the lender, you can foreclose on them. It’s typically the last resort to take the property back, and then once you have the property back, if it didn’t sell at auction, then you could sell it, you could rent it, you could seller finance it. There are multiple exit strategies because you are in control. You are not relying on another bank for your money. You bought it with your cash. It’s like a cash purchase. It gives you the flexibility to control everything.

Key Takeaways And Recommendations For Note Investing

I have plenty of webinars and seminars where we talk about all the exit strategies and everything that can be done. I wanted to touch base on it here that without that leverage, there is a myriad of exit strategies that you can go down. I hope you enjoyed this episode of how notes can be truly passive.

I want to go back and mention to rely on your loan servicers. Understand that there are different types of notes and I would recommend you go first position performing and stay as passive as you need. Non-performing is not what you can’t do. I go second before I go non-performing. Understand that the risk is manageable with the due diligence.

 

You want to understand the story, the borrower, the creditworthiness. We call it the three Ps. The person, the predicament, and the property. I talk a lot about that. How to reduce risk. It’s great that note investing is more affordable than you think to get in, and the most passive way is to invest in a fund. We run a fund where people can invest $5,000 and they get weekly updates from us on deals of the week and quarterly reports and provide all that information for them, but they don’t have to lift a finger. They don’t have to call the servicer. They don’t have to figure out what to do when it goes into default.

That’s what we do, and to be frank, returns are pretty much the same. It’s one of those things where you want to do the work to make a certain amount of money or pay somebody to do the work and pretty much probably end up making the same amount of money. That’s something to consider. I hope you enjoyed this episode as always, leave us a review on your favorite platform. If you want more information about us, go to 7e Investments. Thank you for tuning in and I will catch you on the next one.

 

Important Links

• 7e Investments
• Chris Seveney on Instagram
• 7E Investments on YouTube