How to Create Passive Income by Just Owning Promissory Notes

We’d all love to develop passive income streams. Who wouldn’t want to have money coming in consistently without physically working for it? While no income stream is truly passive, because you do have to invest money, energy, or time initially, but it is possible to set up an income source that pays interest month after month.

What income source am I talking about? I’m talking about buying promissory notes to make consistent returns. But just like we mentioned, it will require time, due diligence, and money on your part in order to get this investment stream rolling. To help you better understand this aspect of investing, we’ll tell you more about it and go into greater detail about the finer nuances below.

What Is a Promissory Note

A promissory note is essentially someone making a promise to pay. Whenever you borrow money, a document is created stating that you are going to pay a lender back. This is the creation of a note. Basically, there are a few very common promissory notes that most people already know about. They include the following:

  • treasury notes
  • contracts for credit cards
  • student loans
  • mortgages
  • loans for businesses
  • loans for personal reasons

So, if you happen to own the note also known as the “note holder”, you are basically stepping in as the lender or banker. You’ll come to terms and the person borrowing money from you will agree to pay it back over a certain length of time for a certain amount of agreed upon interest. As someone granting or buying promissory notes, you can literally earn relatively passive income by collecting payments and interest on a month by month basis until your loans are fully paid back.

The Most Common Ways to Invest in Promissory Notes

Some types of promissory note investing are more common than others. Some of the more common and effective options include:

  • Hard money lending – this type of lending is known as asset-backed lending and typically speaking it will be backed by real property. As an example, if you plan to fix and flip up properties and you’re looking for a loan to purchase a new house and fix it up, you can often find it difficult to get a loan from a traditional lender. Investors can take out hard money loans from a private lender. And if you were to default on the loan, the lender will have a first position lien on the property if you were to default. The lender will legally own your property in this case.
  • Performing real estate promissory notes – if you were to invest in performing real estate notes, you would be investing in notes where the borrower consistently makes their payments month after month. The loan is in good standing and as an investor, you have the option to pay a specific sum of money to purchase the note and you’ll begin receiving the payments instead. Basically, in this situation you become the bank and you will hold the mortgage loan until it’s paid off by the borrower.
  • Nonperforming real estate promissory notes – when you purchase a note that is considered nonperforming, as the lender you realize that the borrower is no longer making payments on these notes. Ultimately, buying this type of note means you are hoping to get paid either through collections or by getting the property in foreclosure. Noteholders in this situation often sell them at a serious discount to make some of their money back because they don’t feel like going through the foreclosure process. If you understand how nonperforming notes work, you could do very well with this investment as long as you know how to navigate collections and foreclosures.
  • Small business lending – when businesses first open their doors they often find themselves in need of startup capital. Many businesses will take out loans from traditional lenders and essentially they will create a promissory note. Sometimes they’ll find it hard to get money from a traditional bank so they will ask private investors for loans which also create a promissory note as well. As a lender, you can create promissory notes and make loans to small businesses. But do your homework and fully vet the business ahead of time because most small businesses fail within the first five years.
  • Peer-to-peer lending – peer-to-peer lending is very popular right now and websites like Prosper and Lending Club are thriving and so are there members. Many people looking for small short-term loans visit P2P lending sites to get a loan to make a small purchase or consolidate debt or they may need the money for a number of different reasons. They ultimately borrow from many investors and promise to pay back the money within a specific period of time. You can enter the world of peer-to-peer lending and collect regular monthly payments and interest from a group of your peers.
  • Treasury notes a.k.a. T notes – these notes have a fixed interest rate and maturity deadline and they come from the US government. This note is basically an IOU from Uncle Sam in which he promises to pay you back your money within 1 to 10 years at a specific interest rate that you will collect every six months. Treasury bills mature in less than a year, treasury notes mature within 1 to 10 years, and treasury bonds reach maturity in 30 years.

Excerpts from BREIA – Broward Real Estate Investors Association. All rights reserved

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