Table of Contents
What Is a Note?
A note is a written promise made by a borrower to repay a lender at a future time. Just like bonds, investors receive interest payments along with their original investment, known as the principal, at a later date.
The issuer commits to pay back both the principal and interest by a certain date. This structure makes notes appealing for family loans, safe-haven options, and various investments.
In more complex cases, notes are used for corporate debts and come in forms such as Treasury notes and municipal notes, which are common types known for their tax benefits and stable returns.
Some unsecured notes offer higher risk because they lack collateral, unlike bills or longer-term bonds. They sit in the middle ground in terms of maturity and structure, making it essential for investors to understand their risks and their role in the market.
Key Takeaways
- Notes are debt securities similar to bonds, but usually have shorter maturity dates.
- Treasury notes (or T-notes) are considered safe-haven investments because they are backed by the U.S. government.
- Unsecured notes carry higher risks and interest rates since they lack collateral.
- Structured notes combine bonds with derivatives to offer potentially enhanced returns.
- Municipal notes provide tax benefits and are often used to fund government projects.
How to Invest in Notes
Understanding the Mechanics of Financial Notes
A note is a type of debt security that involves obligating the repayment of a loan with a predetermined interest rate over a defined time frame. It works like bonds, but with a shorter maturity date and a fixed interest rate, often around 2% per year, and typically mature in one year or less.
In contrast, a bond offers a higher rate of interest and matures over several years, as longer-term debt securities usually provide higher interest rates to compensate investors for their time.
There are also different applications of notes. For example, a loan arrangement called a demand note doesn’t follow a fixed repayment schedule. A borrower can make a demand payment at any time, which is common in informal lending between family, friends, and for small amounts.
Additionally, notes can act as currency, like Euro notes, which are legal tender and paper money in the eurozone, issued in denominations of 5, 10, 20, 50, and 100 euros.
Essential Insights for Investing in Financial Notes
Notes such as mortgage-backed notes are popular investments, created when mortgage loans are bundled and sold as a mortgage-backed security. Investors receive interest payments based on rates from these loans. Some notes include add-on features to enhance return compared to a typical bond.
Structured notes are essentially a bond with a derivative component, which is a financial contract tied to an underlying asset like an equity index. By combining this equity index element with the bond, fixed interest payments are ensured, with a potential enhanced return if the equity portion performs well.
Companies issue both secured and unsecured debt with various maturity dates. A capital note is an unsecured, short-term debt instrument. When a note or bond is issued by a corporation, the principal amount invested may or may not be guaranteed, depending on the financial viability of the corporation issuing the note.
Navigating Tax Advantages of Financial Note Investments
Investors often purchase notes to gain income and tax benefits. Municipal notes, issued by local governments, come with a fixed interest rate and help raise money for infrastructure and construction projects. These notes typically mature in one year or less and may be exempt from taxes at both the state and federal levels.
Protecting Investments With Safe-Haven Treasury Notes
Treasury notes, also called T-notes, are financial securities issued by the U.S. government. They are popular investments because they offer fixed income and act as safe-haven investments during economic and financial difficulties. They are guaranteed and backed by the U.S. Treasury, ensuring the principal investment is protected.
These securities raise money for debts, new projects, and infrastructure improvements, strengthening the economy. Sold in $100 increments, they pay interest every six months and return their full face value at maturity. Their maturity dates span 2, 3, 5, 7, and 10 years, making them longer than Treasury bills but shorter than Treasury bonds.
How to Invest in Notes (Note Investing)
Note investing is a real estate investment strategy suitable for beginners and advanced investors. It provides investment opportunities in real estate without the responsibilities of a landlord or rehabbing property.
As an alternative real estate investment, it offers both passive and active investment options. Real estate notes and mortgage notes allow a mortgage note investor to earn profit monthly as a mortgage note holder.
What is the difference between a Real Estate Note and a Mortgage?
A mortgage note is a promise to pay a debt on a house. It involves a promissory note outlining the terms, agreement, loan, loan amount, percentage rate, payment amount, and timing of payment. It functions like an IOU with a promise to repay, secured by a security instrument such as a mortgage or deed of trust, creating a lien on the property as collateral.
For example, a buyer might pay 20% and borrow 80% from a lender. That lender becomes the mortgage holder, and the mortgage document allows the sell mortgage process to a mortgage note investor. Property owners may receive a letter stating their mortgage payments should now be made to another mortgage lender, as the mortgage note sold to a new lender.
How Do I Get Into the Mortgage Note Game?
A mortgage note can seem expensive, sometimes reaching $100,000, but the mortgage note space offers opportunities through millions of mortgages under $50,000 in the United States, which can be purchased at a discount, giving instant equity.
Mortgage notes are often sold by banks and lenders. Investors can purchase notes for sale through the Note Buyer’s Note Investing Journey, register for the JKP Training Series, or learn through Note Investing 101 and Note Investing consultation.
How Does the Discount Work?
When a homeowner owes $40,000 on their mortgage, the lender may sell the note to a different lender for $35,000, creating $5,000 in equity. The homeowners still owe the original mortgage, even after it’s sold, allowing the investor to gain a higher effective yield than the interest rate on the note, which can result in an above average return.
Key Types of Financial Notes: Unsecured, Promissory, and Convertible
Governments and companies issue various types of notes with unique characteristics, risks, and features.
Unsecured Note
An unsecured note is a corporate debt instrument without collateral, typically lasting three to 10 years, with varying interest rates, face value, maturity, and terms. For example, Company A might buy Company B for $20 million, using $2 million cash and issuing $18 million in unsecured notes to bond investors.
Without collateral, if the acquisition fails, the company may default, leaving investors with little compensation after liquidated assets are sold to pay back investors.
Such notes rely on a promise to pay, making them speculative and riskier than other bond investments, and they offer higher interest rates than secured notes or debentures, which are supported by insurance policies if a borrower defaults on a loan.
Promissory Note
A promissory note is written documentation of money loaned or owed between parties, including repayment schedules, interest rates, and payment information, signed by the borrower (issuer) and given to the lender (payee) as proof of the repayment agreement.
The phrase pay to the order of indicates where payments go, which may be the lender or a third party. For example, Sarah borrows from Paul in June, lends to Scott in July, and issues a promissory note, directing Scott’s payments to Paul until Sarah’s loan is paid in full.
Convertible Note
A convertible note is often used by angel investors in early business stages without a clear company valuation. This loan converts to equity when later investors buy into the company.
For example, an angel investor might invest $100,000 using a convertible note, while an equity investor puts in $1 million for 10% of the company’s shares. The angel investor’s note converts to one-tenth of the equity investor’s claim, sometimes with additional shares to compensate for risk as an earlier investor.
FREQUENTLY ASKED QUESTIONS:
The Bottom Line
Investment notes are a type of debt securities that pay interest and return principal, effectively bridging the gap between short-term bills and longer-term bonds. They include options like safe-haven Treasury and tax-exempt municipal notes, as well as higher-yield, more riskier, unsecured notes.
Their flexibility makes them suitable for personal loans, corporate financing, and diverse market strategies. Investors should carefully weigh each investment’s risk, potential return, and tax implications to make informed decisions.
📚 Explore More Smart Money Guides
If you're interested in growing your financial knowledge, check out these related articles from Youth Budget:
