Where does your profit come from when you buy a note?

[Macintyre Gallagher]

Where does your profit come from when you buy a note? From what I understand, when you buy a note you are becoming the lender to the homeowner and then they must pay you their mortgage payments per month. Do you then pay the bank back with that money? If so, how do you make a profit off of these?

Thanks,

Mac Gallagher

[Dion DePaoli]

As a note investor you purchase the note and security instrument and the payments come to you.  You would have cashed out the prior note holder in typical sales.  So you don't have anyone to pay unless you borrowed capital to purchase the note yourself.

The profit from a loan comes from the interest payment and principal discount, if any.  In a loan purchased at par (100% of balance due) you are simply collecting the interest on that loan as the principal is a return of your own capital.  

If you purchase the loan at a discount that discount (<balance due) is on the principal amount due on the loan and a portion of that becomes interest income for you the investor.  

In some scenarios you can earn above those two items by collect advances made on the note prior to your ownership.  That is money a previous holder put out to pay for things like taxes, insurance and some other concepts.  If you didn't capitalize those costs then when those are collected they flow into you interest income as well.