Non-performing notes are real estate-backed loans in which the borrower has failed to make monthly payments for 90 days or more.

When a borrower stops paying, the lender, often a large bank, is quick to offload the loan, eager to avoid the headache of foreclosure. Rather than wait around hoping the borrower resumes payments, they sell the note to free up capital and get back to making new, performing loans.

Debt resolution experts, such as real estate debt funds, purchase non-performing notes from lenders at a discounted rate to the loan balance and seek to recover the full balance. Depending on the borrower's situation and market conditions, they can do this in multiple ways: through loan restructuring, foreclosure, or resale of the asset.

To give you an idea of the returns that non-performing notes can yield, the Constitution Lending non-performing loan fund generated a 57.60% return for our investors in 2024.

This article discusses the benefits of investing in non-performing notes, the risks to consider, and how to invest in them. We also cover a few examples of deals we have completed in the past.

Who are we? We are Constitution Lending, a real estate credit fund specializing in acquiring and recovering non-performing notes. Since our inception, we have successfully purchased and recovered over $40MM in distressed debt. If you'd like to learn more about our investing strategy, book a 30-minute call with a portfolio manager.

Benefits of Investing in Non-Performing Mortgage Notes

Higher Returns than Traditional Fixed-Income Investments

Non-performing notes can generate significantly higher returns than performing notes and traditional fixed income investments for two reasons:

• Non-performing notes are typically sold at discounts to the unpaid balance owed by the borrower
• Non-performing notes have higher interest rates than performing loans

Non-performing Notes Are Sold at Discounts to the Unpaid Balance Owed by the Borrower

Non-performing mortgage notes are sold for less than the loan balance because the borrower has defaulted. Banks want to avoid tying up capital in distressed assets and quickly free up funds to originate performing loans, so they often sell them at a discount.

Investors can generate strong returns by purchasing these discounted notes and recovering the full loan amount. They can do this in various ways, such as through foreclosure, short sale, loan modification, or getting the borrower to resume payments and reselling the performing loan.

For example, we recently purchased a non-performing note for $6MM secured by a condominium in New York City with an unpaid balance of $10MM. Recovering the $10MM loan balance will generate an approximate return of 66%.

Non-performing Real Estate Notes Have Higher Interest Rates than Performing Loans

Another reason non-performing mortgage notes have the potential for such high returns is the loan default interest rate.

When borrowers take out loans and make payments on time, they pay the contract rate, which is essentially the normal interest rate.

However, as soon as they default on the loan, they start paying the default interest rate, a higher interest penalty ranging from 18% to 24%.

The difference between the contract rate and the default rate is that the borrower usually doesn’t pay the monthly default rate. They have already defaulted.

Instead, investors add the default interest rate to the balance the borrower already owes until the debt is paid, providing compounding returns while the debt is resolved.

At Constitution Lending, we can reliably recover this default interest debt because we only buy loans where the balance is well below the property’s value. As a result, we have a large borrower equity cushion, allowing us to accrue default interest, sell the property, and recover the full loan amount (including default interest) from the sale proceeds.

Strong Asset-Backed Security with Significant Equity Cushion

Non-performing notes prioritize capital protection because they are secured by real estate. If the borrower defaults, investors have the right to take control of the property, sell it, and apply the proceeds toward repaying the outstanding debt.

For additional capital protection, funds like Constitution Lending purchase notes where the loan amount is substantially less than the collateral’s value. Most of the non-performing notes in our fund have a loan-to-value (LTV) ratio of 60%. This means that if a property is worth $1MM, the loan amount would be $600K.

This 40% borrower equity cushion offers numerous advantages from a risk mitigation perspective:

• It protects against market volatility: The property can lose value by up to 40%, and investors won’t experience a principal loss. Investors in the real estate note can sell the property for 60% of its initial value and recover their full investment. The borrower’s equity absorbs the entire loss.

• It protects against default risk: Investors can safely add default interest to the borrower’s balance and earn compounding returns throughout the foreclosure process while being well-positioned to recover the full loan amount. There’s less risk of the unpaid balance exceeding the property's value.

With Constitution Lending, all the loans in our fund have an LTV of 60% or less — with some having LTVs as low as 10% to 20% — providing our investors with significant downside protection.

Multiple Pathways to Profitability

Non-performing mortgage notes can be paid off in numerous ways, including through loan modification, deed-in-lieu, short sale, or foreclosure. This flexibility gives investors multiple opportunities to extract value from a distressed asset, depending on the borrower's circumstances, the condition of the collateral, and market dynamics.

Rather than being locked into a single exit strategy, mortgage note investors can pivot toward the most advantageous resolution strategy on a case-by-case basis.

If a borrower is cooperative but financially constrained, a loan modification can enable investors to turn a non-performing loan into a re-performing one, generating strong cash flow by increasing its value and selling it at a profit. If the borrower is unwilling or unable to cure the default, a deed-in-lieu or foreclosure can expedite asset recovery without expensive legal action.

Counter-Cyclical Investment Potential

Investing in non-performing notes gives investors a hedge against stock market fluctuations. Real estate-backed debt returns aren’t as correlated with the stock market as traditional equities or mutual funds. Its performance is primarily driven by local property values and homeowner behavior rather than broader equity market trends.

Additionally, non-performing notes are one of the few asset classes that can benefit from stock market slumps. During economic downturns, loan defaults tend to rise as borrowers struggle to meet their obligations, increasing the number of non-performing notes on banks' balance sheets — debt they’re often desperate to offload. As a result, banks are typically more willing to sell these notes at steeper discounts to reduce risk and free up liquidity.

Investors can purchase non-performing assets at more significant discounts during downturns and generate even greater returns.

Where to Find and Buy Non-performing Promissory Notes

Investors can find and purchase non-performing loans by:

• Investing in a real estate debt fund
• Buying non-performing notes from banks
• Using a broker
• Shopping for notes on a marketplace

Invest with a Fund

The most accessible way to invest in non-performing notes is through a fund, as you don’t have to purchase, manage, and resolve distressed debt yourself.

Buying non-performing notes directly by yourself is a highly specialized skill that requires you to underwrite distressed debt, learn about local real estate markets, execute legal strategies, negotiate with borrowers, and decide whether to restructure, foreclose, or sell. Most regular investors don’t have the expertise or experience to do this.

In contrast, when you invest with a real estate debt fund like Constitution Lending, which has purchased and recovered over $40MM worth of non-performing notes, you get access to professionally managed loan portfolios without worrying about the operations of debt resolution. You simply receive distributions proportional to your percentage in the fund every quarter.

Another benefit of commercial real estate debt funds is that you can invest at a fraction of the price it would normally cost to purchase non-performing mortgage loans yourself. To buy loans from banks, you need at least $1MM to $2MM and additional funds for legal fees.

However, with a non-performing loan fund like Constitution Lending, investors can start with just $20K.

How to Evaluate a Real Estate Debt Fund and Make Informed Decisions

Before you invest in a non-performing notes fund, we advise considering the following factors to ensure you’re investing in high-quality assets:

• Track record and recovery rates: We recommend researching and asking about the fund’s recovery rates, i.e., the percentage of deals in which they successfully recovered the full loan amount. This gives you a good understanding of their debt resolution expertise. At Constitution Lending, our background lies in debt resolution, and we’ve recovered over $40MM in NPLs.

• LTV: Ask about the average LTV of the mortgage loans in the fund and choose one with an average LTV of 60% or less. This means that loans are backed by collateral worth significantly more than the owed amount, protecting investors from market and default risk. Constitution Lending’s non-performing loan fund has an average LTV below 60%.

• Historic returns: Although a fund’s past performance doesn’t impact future results, it’s still necessary to review its historical returns, as they show the potential of its investing strategy. In 2024, Constitution Lending’s non-performing note fund returned 57.60% to investors.

• Diversification: A well-diversified fund reduces exposure to any single borrower, property type, or geographic market. By spreading capital across a wide range of loans, the fund mitigates the impact of defaults or market downturns. With Constitution Lending, we purchase non-performing notes secured by residential, commercial, and industrial properties located all over the U.S.

• Fee structure: Many funds charge performance-based fees like carried interest or profit-sharing, which are designed to align the manager’s incentives with investor returns. While these structures can motivate strong performance, it's essential for investors to understand how and when these fees are calculated and triggered.

• Investor liquidity: Some funds allow investors to redeem capital quarterly or annually, while others require a multi-year commitment with no early withdrawals. With Constitution Lending, we have a lock-up period of 18 months, after which we pay investors quarterly.

How to Invest with Constitution Lending

Joining the Constitution Lending non-performing note fund is simple:

1. Book a call with a portfolio manager who will walk you through our investment strategy, answer your questions, and help determine if our fund aligns with your investment goals.

2. Confirm your eligibility by submitting documentation such as tax filings, proof of income, or statements demonstrating that you’re an accredited investor.

3. We’ll email you the investment paperwork via DocuSign for your review and electronic signature.

Buy Non-performing Notes Directly From Big Banks

Big banks are often the original holders of non-performing loans, making them a logical source for those seeking direct exposure to large NPL pools. These institutions typically offload distressed debt to clean up their balance sheets and reduce regulatory pressure.

However, this access comes at a premium. Banks tend to sell in large tape sizes with significant minimum bid thresholds — often around $1MM to $2MM — making them more inaccessible to regular investors. 

You’ll also need to have established relationships with these banks, underwrite the loan documents, service the loan, and resolve the debt yourself.

Investing with a non-performing loan fund like Constitution Lending is more practical because you can start investing with just $20K and capitalize on our underwriting and debt resolution expertise.

Use a Loan Broker for Mortgage Note Investing

Note brokers act as intermediaries between sellers (often banks or hedge funds) and investors, offering curated non-performing loan deals that are generally smaller in size. They provide ease of access and relationships that many newer investors rely on to enter the space.

However, while note brokers remain a popular choice for many investors, we suggest avoiding them — they are often why investors buy bad loans.

Brokers typically don’t hold the loans themselves. They’re incentivized to close deals, not ensure their quality. That means some brokers may pass along poorly performing or overvalued notes without much scrutiny, knowing they won’t bear the consequences. It's common to find chain-of-title issues, inflated valuations, or loans with undisclosed legal complications in broker-sourced deals.

With Constitution Lending’s non-performing loan fund, we have our own capital in the fund, so we are invested alongside you.

Shop on Note Marketplaces

Online marketplaces have emerged as a way to participate in mortgage note investing. These platforms aggregate listings from banks, servicers, and hedge funds, offering individual notes and small pools across the U.S. Investors benefit from greater transparency, competitive pricing, and detailed loan data, sometimes with digital bidding and escrow services built in.

The trade-off with marketplaces is that you're the underwriter and the full burden of due diligence on the buyer. There’s no one vetting these deals and loan terms for you, and many note holders may still list poor-quality paper. You need to underwrite things like the purchase price versus the total payoff, property taxes, the collateral’s true value, the borrower's repayment plan, and more before buying.

When you invest with a fund like Constitution Lending, you leverage our experience and expertise in debt resolution.

Invest in High-Yield Non-performing Notes with Constitution Lending

You can learn more about our approach to buying and resolving non-performing real estate debt by scheduling a call with a portfolio manager.