To buy a mortgage note from a bank, you form a legal entity, prove you have the funds, get on a bank’s approved buyer list (usually through its special assets or secondary marketing group, or an external loan sale advisor), sign a non-disclosure agreement to see the loan file, price the note against its unpaid balance, and close through a Loan Sale Agreement that transfers the note and records a new lien assignment in your entity’s name. After closing, you take on federal servicing, notice, and tax obligations that begin the day the loan changes hands.
Everything below walks that process in order, from the first decision you have to make to the paperwork you’ll owe the IRS the following year.
Decide Whether You Want a Performing or Non-Performing Note
This choice comes before anything else because it changes your price, your workload, and your legal exposure.
A performing note is one the borrower is paying on time. You buy it and monthly payments start arriving. Because the income stream is reliable, performing notes trade at prices closer to the unpaid principal balance. Discounts exist, but they are modest.
A non-performing note is one where the borrower has stopped paying. Banks are motivated sellers because these loans drag down their balance sheets and push up reserve requirements, and that motivation shows up as steep discounts. The return depends on your exit: negotiating a modification, accepting a discounted payoff, or foreclosing and selling the property. Foreclosure timelines range from a couple of months in non-judicial states to well over a year in judicial states, and contested cases or borrower bankruptcies stretch that further.
There is a legal wrinkle worth knowing at the outset. If the note was already in default when you bought it, federal law may classify you as a “debt collector,” which brings a separate set of rules covered later. Performing note buyers generally sit outside that regime.
Form Your Buying Entity and Line Up Proof of Funds
Banks do not sell mortgage notes to individuals in their personal capacity. You need an LLC or corporation before a seller will take you seriously. The entity provides liability protection and keeps the documentation chain clean.
Form your entity and pull your Articles of Incorporation or LLC Operating Agreement together before you contact anyone. These prove the entity exists, is in good standing, and can enter financial contracts. Every document in the transaction, from the NDA through the final assignment, will reference the entity’s name, so use it consistently from the first call.
You’ll also need Proof of Funds: a recent bank statement or a formal letter from a financial institution confirming available capital or a line of credit. The name on that document must match the entity name exactly. Banks use it to confirm you can close before they share proprietary loan data with you.
Find the Banks Actually Selling Notes
Large national banks generally hire outside loan sale advisors or brokerage firms to run portfolio dispositions. These intermediaries handle marketing, screen buyers, and manage bidding. Getting on their distribution lists usually means submitting your entity documents and proof of funds upfront.
Smaller regional and community banks are where individual buyers often have better luck. They tend to run note sales internally through two departments. The special assets group handles troubled loans the bank wants off its books. The secondary marketing group deals with performing paper being sold for liquidity reasons. Which door you knock on depends on which type of note you’re after.
Cold outreach works, but it takes persistence. Call or email asset managers directly. These are the people responsible for minimizing losses on the bank’s balance sheet, and they have authority to initiate a sale. Ask to be added to the approved buyer list so you hear about notes as they come available. The buyers who see deals before they hit the open market are usually the ones who followed up for months before a note came loose.
Get Through the NDA and Qualification Gate
Once a seller is willing to talk, you sign a Non-Disclosure Agreement before you see any loan-level data. The NDA protects the borrower’s personal information and the bank’s proprietary data. It typically prohibits you from contacting the borrower directly or sharing loan details outside your deal team. Sign it in your entity’s legal name, not your personal name.
After the NDA, you submit your entity documents and proof of funds for compliance review. Only after you pass that screening do you get access to the actual loan data. Expect anywhere from a few days to a couple of weeks depending on the bank’s internal process.
Review the Loan Tape and Collateral File
The Loan Tape
The bank sends a loan tape, a spreadsheet with the key data on each available note: unpaid principal balance, interest rate, maturity date, last payment date, and payment status. The last payment date tells you whether the note is performing or how deep the delinquency runs. Deeper delinquency usually means a steeper discount and a more complicated workout.
The Collateral File
The collateral file holds the legal documents that secure the debt. At minimum, it should contain the original promissory note (the borrower’s signed promise to repay) and the mortgage or deed of trust (which ties the debt to the property). The promissory note is the instrument you are actually buying. The mortgage or deed of trust is what gives you the right to foreclose if the borrower defaults. Both need to be present, properly executed, and reference the right borrower and property. A collateral file missing the original note creates serious enforcement problems later.
Title, Liens, and Property Taxes
Review the title insurance policy to confirm no superior liens threaten your position. Property tax status matters especially. Unpaid property taxes create a lien that takes priority over your mortgage, meaning a taxing authority can foreclose ahead of you and wipe out your interest entirely. On non-performing notes, delinquent taxes are common and can be a significant hidden cost.
The payment ledger tracks every payment the borrower has made, plus late fees and escrow balances. A borrower who was late six times last year but is technically current today is a very different risk from one with a clean history.
Property Valuation
You need an independent estimate of what the property is worth. Most note buyers order a Broker Price Opinion from a local real estate professional rather than paying for a full appraisal. An external BPO involves the broker evaluating the property from the outside and comparing it to recent sales of similar properties nearby. The ratio between your purchase price and the property’s value, known as the investment-to-value ratio, is one of the most important numbers in your analysis. A larger equity cushion means more protection if you eventually foreclose and sell.
Price the Note
Mortgage notes trade at a percentage of the unpaid principal balance. Paying the full balance is called par pricing. Paying less is buying at a discount, and the discount is where your yield comes from.
The simplest way to evaluate a performing note is to calculate the annual yield on your purchase price. Multiply the monthly payment by 12, then divide by what you paid. A note with a $650 monthly payment bought for $65,000 yields roughly 12% ($650 × 12 ÷ $65,000). The same note bought at par of $80,000 yields about 9.75%. The discount does the work.
For a more precise number, note investors calculate an internal rate of return that accounts for the time value of money, the remaining term, and the expected payoff timeline. Spreadsheet IRR functions handle the math. The key inputs are purchase price, monthly payment, number of remaining payments, and any balloon payment at maturity.
Non-performing notes work differently because there is no current cash flow. Your return depends entirely on the workout outcome: how much the borrower eventually pays through a modification or payoff, what the property sells for at foreclosure, and what your carrying costs (property taxes, insurance, legal fees, and time) come to along the way. The deeper the discount, the more room you have for things to go wrong and still make money.
Bid, Sign the Loan Sale Agreement, and Close
The Letter of Intent
You formalize the offer through an indicative bid or Letter of Intent. It states your proposed price, your due diligence period (typically 30 to 60 days), and your expected closing date. For non-performing notes, you may add conditions like updated title work or confirmation of occupancy status before you commit.
If the bank accepts, both sides negotiate a Loan Sale Agreement (sometimes called a Sale and Purchase Agreement). This contract defines the legal terms of the transfer: seller representations and warranties about the loan’s status, the documents being delivered, and any post-closing obligations. Read the representations carefully. They determine your recourse if the collateral file turns out to be incomplete or the loan data was wrong.
Earnest Money and Wire Funding
Banks typically require an earnest money deposit once the agreement is signed. The amount varies but generally runs between 1% and 10% of the purchase price. You wire the balance within the timeframe the contract specifies. Missing that deadline can cost you the deposit or the deal.
Wire fraud is a real threat on any transaction involving wired funds. Before sending money, verify the wiring instructions through a channel you established independently. Call the asset manager at a number you obtained directly, not one taken from an email. Never follow wire instructions received solely by email, and never email financial information. Confirming account names and numbers verbally with a known contact is the single most effective way to prevent a misdirected wire.
Assignment and Document Transfer
After funding, the bank prepares an Assignment of Mortgage (or Assignment of Deed of Trust, depending on the state) to transfer the lien to your entity. Record it with the county recorder’s office. Until it is recorded, third parties have no way to verify your interest, which creates problems if the borrower refinances or another creditor tries to claim priority.
The seller also delivers the original collateral file, often with a bailee letter that serves as a receipt and set of legal instructions governing possession of the originals during the transition. The original promissory note should be endorsed to your entity or endorsed in blank. Under UCC Article 3, a note endorsed in blank is a bearer instrument the holder can enforce. Confirm the endorsement is there and correct. Without it you may lack standing to enforce the note or foreclose.
What You Owe After Closing
Loan Servicing
Once you own the note, someone has to collect payments, manage escrow accounts, send statements, and handle borrower communications. You can do this yourself for a small portfolio, but most buyers hire a licensed third-party servicer. Monthly servicing fees typically run $17 to $30 per note for performing loans, with setup fees and possible surcharges for escrow tracking or non-performing loans. Using a servicer also helps you stay compliant with federal servicing rules, which is worth the cost if you’re not deeply familiar with the regulatory landscape.
Many states require a license to service mortgage loans, and some require a separate license to collect on defaulted debt. Requirements vary by state, so check with your state’s financial regulator or the Nationwide Multistate Licensing System (NMLS) before you start collecting payments.
Borrower Notification Requirements
Federal law requires borrower notification when servicing changes hands. The previous servicer must send a “goodbye” letter at least 15 days before the transfer takes effect, and the new servicer must send a “hello” letter no more than 15 days after the effective date. The two notices can be combined into a single letter, but only if delivered at least 15 days before the transfer. In cases involving contract termination for cause or bankruptcy, the timeline extends to 30 days after the transfer date. During the 60-day period following the transfer, the borrower cannot be charged a late fee if they mistakenly send payment to the old servicer.
FDCPA Compliance for Non-Performing Notes
If the note was already in default when you acquired it, you may be classified as a debt collector under the Fair Debt Collection Practices Act. The FDCPA excludes from its definition anyone who acquires a debt that “was not in default at the time it was obtained,” which means the exclusion does not protect buyers of non-performing notes. As a debt collector, you’d be subject to restrictions on when and how you contact the borrower, required debt validation notices, and prohibitions on deceptive or harassing practices. Violations carry statutory damages, so this is not a technicality you can ignore.
Performing note buyers generally fall outside the FDCPA because the debt was not in default when they acquired it. It’s one more reason the performing versus non-performing distinction matters before you buy.
Force-Placed Insurance
As the lienholder, you have a financial interest in keeping the property insured. If the borrower lets coverage lapse, you or your servicer may need to place force-placed insurance on the property. Federal rules impose strict notice requirements before you can charge the borrower for that coverage. You send a first written notice at least 45 days before assessing the charge, followed by a reminder notice at least 30 days after the first notice and at least 15 days before the charge takes effect. The borrower then has 15 days after receiving the reminder to provide proof of coverage before the charge can be assessed. Force-placed insurance is expensive, often several times the cost of a standard homeowner’s policy, so factor it in when analyzing non-performing notes.
Tax Reporting
If you receive $600 or more in mortgage interest during the year in the course of a trade or business, you must file IRS Form 1098 for each borrower. The obligation applies to the calendar year you own the note. You’d file the form in early 2027 for 2026 interest, for example. If you hold a single note on a former personal residence and the buyer makes payments to you, the IRS does not require Form 1098; the reporting obligation applies to interest received in the course of a trade or business.
When you buy a note at a discount below its remaining balance, the difference between what you paid and what you eventually collect may be treated as market discount income under federal tax rules. Generally, market discount is recognized as ordinary income when you receive principal payments or when you sell the note. You can elect to include market discount in income as it accrues each year rather than deferring it, which can smooth out your tax liability. The tax treatment of discounted notes is one of the more technical areas of note investing, and working with a tax professional familiar with debt instruments is worth the cost to avoid surprises at filing time.