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Wealth Machines: High Yield Non-performing Mortgage Backed Note Investing Case Study

Is it possible to get 12%/yr returns before taxes on a typical investment?

If you look hard, have connections you may be able to find such obscure investments.

They look like the typical scams but if you understand the details, you may not see them the same way.

This post introduces you to potentially a very different form of wealth machine that is based on your typical instruments such as exchange traded funds, stocks, bonds, preference shares, insurance endowments.

These instruments may or may not be available to you and as far as I know they are not very prevalent in this part of the world.

The idea of wealth machines is NOT a focus on how much the financial instruments can make, but having the knowledge, wisdom and the sound execution to build wealth with them on a consistent basis.

When reading do be aware of the following considerations:

  1. Return per unit Risk
  2. How much upfront and recurring effort require to maintain the wealth machine
  3. What are some of the risk events, the probability of the event happening and the effect on your principal
  4. Unique features of the instrument and the wealth machine

What are Non Performing Mortgage Backed Notes in General

Mortgage backed notes typically gives you the right to collect mortgage from someone else. The most common form of lending is from the banks who lent to commercial companies, or individuals like you and me when we need to purchase something that is out of reach at that current point in time, such a home for living.

A typical home owner borrows $100,000 in mortgage from a bank.

In some cases, the home owner cannot continue to pay the mortgage. In this case, this mortgage becomes non-performing.

The bank or lender have the option of foreclosing the home or property and then selling off the property to get some value back.

In some countries when a large amount of their loans are non-performing, the banks might not want to foreclose so many homes.

As such they decide to package and sell these loans off as mortgage notes.

What a Non-performing Mortgage Buying Firm will do

There will be prospective investors in these mortgage notes. Let’s call such a firm Firm a.

Firm A will buy some of these loans from the bank. Their intention is to resell the loan notes to the other smaller investors.

Firm a will call up the non-performing mortgage owners to find out why they aren’t paying the mortgage.

The typical reason is that their housing value went down so much that they don’t have an incentive to pay off their mortgage monthly. There could be other reasons.

In some cases, Firm A can provide a win win situation for the non-performing mortgage owners by reducing the principal that they have to repay at the expense of higher interest.

So for example, a non-performing mortgage owner could have $100,000 value on his original mortgage. when the value of the home goes down, there are less incentive to repay.

Firm A can offer a $10,000-$25,000 discount so that the amount that he owes is only $75,000.

Why Firm A can offer such a discount is because typically these non-performing loans are sold by the banks at a fraction of their original value, for example, $10,000 – $15,000 in this case.

The Returns on these notes

Firm A will then sell these notes to investors. Typically, they will mark up a $10,000-$15,000 loan to $25,000 and sell it.

As a note investor, your return could be as high as 12%/yr.

That looks a splendid return, but if these notes start selling like hot cakes, Firm A could mark up the principal and your return per year will be lower.

As an investor you get something like a bond. You get interest payment yearly, until the loan is repaid, where you get back you principal.


Unable to Depreciate like Properties

Compared to properties, you could deduct a portion of the home value in your income tax statement to reduce the taxable amount.

This is not available if you invest in the note.

Further more, as interest income, you are likely to have to pay taxes on the returns, so your after tax returns might not be what is stated.

Unable to increase rent

You are not able to raise rent like a typical property rented out to tenants when times are good. What you see is what you are going to get.

Liquidity Issue

Compare to your typical bond, there isn’t a liquid secondary market, where you are able to sell the note, to raise liquidity if you have some form of emergency, or to redeploy into an instrument with a higher return per unit risk.

This is somewhat similar to if you invest in loans via a crowd funding platform such as Capital Match, Moolah Sense, New Union, Funding Societies or a land banking company like Walton.

Loans may still default again

While the company may have got the underlying mortgage owner to start paying again, there are every chance that they would default again.

Loans may pay off early

In the event where the owner sells of the home, the loans get repaid in full, your principal will be returned. The same if it is a refinance.

You would have to plan to reinvest the money early.

Less Recurring Effort Management compared to Real Estate Rental

In comparison to purchasing and renting out real estate, this way of investing reduces the hands on effort of finding tenants, negotiating with tenants, taking care of maintenance of the property as well as rent collection.

You might prefer this form of Wealth Machine, by holding a portfolio of notes, if you have a hectic day job that is more rewarding, where you really do not want to be bother with the day to day rental issues (even though you can engage a property manager to take care of such tasks by paying them a fee for it.)

Predictable Internal Rate of Return but Unpredictable Default risk

Similar as a bond, you should be able to compute your yield to maturity since there is no capital appreciation if you held it to maturity. This yield to maturity should equate to your internal rate of return (IRR), your return per year when the net present value of the cash flow you put in is 0.

The problem is that if they default on the payment your IRR would look dramatically different.

Your Risk Management on Conscious Knowledge of Default Risk

With the risk of underlying mortgage buyer defaulting again being real, some things that you need to consider are the following.

Access to specialize resources to turn around the situation

These notes when it comes to management can be pretty low in recurring efforts. However, when such risk event occurs does the firm you purchase the note with, in this case Firm A, have the lawyers and resources to issue legal notices, the appropriate courses of action to help turn around the situation?

Would you in your own capacity have access to those kind of resources, if you are a seasoned active real estate investor.

Foreclosing the Property

If you have taken care of having the specialize resources to facilitate such a more hands on management of the underlying mortgage, you could proceed to foreclose the property and sell off.

In this aspect, perhaps the safe guard is to ensure that the principal value of the note you have purchase is more than the prevailing value of the property.

In this way, you have a higher likelihood to get back most of your principal value.

Taking over the leasing of the Property

The default could very well be due to various reasons, but the underlying is still a property that can be let to a different renter that is capable of paying.

This could very well turn to another house for rent if you are an active real estate investor


The returns are very appealing, but the probability of the instrument having capital loss is very real. This is certainly more so than purchasing a bond from a listed business (which is not to say there isn’t default risk, just that its on a different probability scale)

This also highlights the importance of looking it as a well oiled wealth machine. The instrument which is the note here, is there to serve, but under a wealth builder with knowledge, resources and execution, he could very well protect his downside very well to mitigate the capital loss risk.

This form of security may not be prevalent and perhaps can be rather unregulated now, and when marketed to investors who don’t want to acquire the competency, might be truly a scam in the making.

To another private investor with the resource, this could be a good way to acquire consistent cash flow to pay down their debt amortization for their other properties.

To get started with dividend investing, start by bookmarking my Dividend Stock Tracker which shows the prevailing yields of blue chip dividend stocks, utilities, REITs updated nightly.
Make use of the free Stock Portfolio Tracker to track your dividend stock by transactions to show your total returns.



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