Unveiling Notes Receivable: Fueling Financial Growth for Note Holders

Mortgage note holders owe it to themselves to understand the nature of the asset they’re sitting upon. Notes receivable are valuable, if often misunderstood, components of an investment portfolio. They can be a powerful tool, but only when used correctly.

This short guide will take a closer look at notes receivable. You’ll find out what they are, how they can benefit you, and why investors prize them so highly. Read on to find out. 

What Are Notes Receivable? 

A note receivable is a written promise. It works as a legal obligation between a lender and a borrower, guaranteeing payment for whoever holds the mortgage note. The borrower is legally required to repay the mortgage indicated, as outlined in the terms of the agreement between both parties, according to the payment terms agreed upon in advance. 

The ability to enforce the terms of the agreement is the most important factor here. The investor or company that holds the note has the legal authority to enforce the terms of the agreement to receive the amount due. They have many options for doing this, up to and including: 

• Selling the mortgage note to another mortgage note buyer. The holder of the mortgage note could then receive payment for the mortgage right away, instead of waiting for the terms of the agreement to reach their maturity date.
• Seek a judgment against the borrower. The mortgage note holder can seek out a court order demanding payment of the note’s remaining balance at the threat of legal action. 
• Foreclose on the borrower. If the borrower reneges on the terms of the agreement, the mortgage note holder can start foreclosure proceedings to force the sale of the property. This would then allow them to make themselves financially whole. 

As a promissory note, notes receivable allow the maker of the note to diversify their portfolio with a flexible asset that can offer period interest and consistent returns. In addition, these assets potentially have a lower risk portfolio than others because the terms of the agreement are legally enforceable. If something goes wrong with the original agreement, the lender can take steps to protect themselves against a loss of the principal amount. 

Key Components of Notes Receivable

From the perspective of a note buying company, the components of a notes receivable are crucial for evaluating the viability and value of the investment. These components include:

• Principal amount: This is the original sum of money lent or financed, which the borrower is obligated to repay. The principal amount forms the basis of the note and is a key determinant in the calculation of interest and total repayment amount.
• Interest rate: The interest rate attached to the note is critical as it affects the profitability of the note from an investment perspective. Higher interest rates can yield higher returns, assuming the risk level of default is acceptable.
• Payment schedule: Details about the frequency and amount of payments are vital. Whether payments are due monthly, quarterly, or on another basis influences the cash flow and the management of that flow for the investing company.
• Term of the note: The duration over which the borrower must repay the loan affects the note’s risk and return profile. Shorter terms may involve higher payments but less credit risk and quicker returns on investment, while longer terms may provide steadier, but slower returns.
• Security or collateral: Notes secured by collateral, such as real estate or other valuable assets, are generally more attractive as they reduce the risk of loss in the event of default. The type and value of the collateral are assessed to ensure it adequately covers the note’s value.
• Borrower’s creditworthiness: The financial stability and credit history of the borrower play a crucial role in the risk assessment of the note. A borrower with a strong credit history is less likely to default, making the note more secure.
• Amortization: Understanding whether the note is fully amortizing, partially amortizing, or interest-only is important for predicting the future cash flows and final balloon payments, if any.
• Recourse vs. non-recourse: This determines if the lender can claim other assets from the borrower beyond the collateral if the note goes into default. Non-recourse notes are riskier but common in certain types of transactions.

Accounts Payable vs. Notes Receivable 

Although some people tend to mix up accounts payable and notes receivable, it’s important to note that they are two different types of transactions. In the simplest terms, accounts payable are business liabilities, whereas notes receivable are assets. 

Accounts payable consist of money the business owes to another party. Businesses frequently rely on debt from suppliers to carry out operations, resulting in accounts payable on their ledgers. Resolving the accounts payable on its balance sheet is one of a business’s primary responsibilities. 

Notes receivable, on the other hand, can be a source of income for an organization. Whenever borrowers take credit loans for products and services, the organization creates journal entries to record these transactions. The business adds corresponding credits and debits to the journal entries upon receiving each new payment. Over time, notes receivable can provide a source of predictable cash flow and stability. 

Notes Receivable vs. Notes Payable

Notes receivable typically arise when you, as a property seller, opt to finance the purchase for the buyer. This might occur if the buyer cannot secure traditional financing or prefers not to use it. By offering seller financing, you create a note receivable: a financial instrument that dictates the buyer will make regular payments to you, usually including interest, until the full purchase price is settled. 

On the other hand, notes payable come into play when you, as a real estate investor or developer, take on debt to finance property purchases or development projects. For instance, if you purchase a property with a mortgage or secure a loan to develop a real estate project, you generate a note payable. This note outlines your obligation to repay the borrowed funds under specified conditions, including repayment schedule and interest. These notes are classified as liabilities on your balance sheet because they represent future cash outflows that you are legally obliged to make.

Should Promissory Notes Be Considered Assets? 

Notes receivable do not exist in a vacuum. They’re backed by the strength of the property. The borrower may take possession of the property, but if the borrower can’t fulfill the contract, the lender can unlock the property’s value to secure their balance sheet. In other words, the property itself acts as a security for the mortgage loan, and the value of the property will parallel the value of the loan. 

As such, it’s correct to view promissory notes as assets. This is not a weak contract. There’s risk for the lender, as with any investment, but the range of legal options available to them reduces that risk substantially. And because the promissory note is indeed an asset, accruing a consistent interest rate, the holder can sell or exchange it with someone else when they wish to do so. 

Moreover, it’s possible to borrow against the note, just as you would with another kind of asset, if you need money right away. This is called real estate hypothecation. But remember that this isn’t a completely safe investment. Mortgage note holders need to conduct careful risk management to determine the ability of a borrower to honor the agreement. And although you can sell the mortgage note, you’re not guaranteed to receive the full value of the note when you do so. 

Btw, learn here the differences between a promissory note and loan agreement.

Is a Notes Receivable a Current Asset?

Whether a notes receivable qualifies as a current asset depends on the expected timing of the payments due under the note. Generally, a notes receivable is classified as a current asset if it is expected to be converted into cash, sold, or consumed within one year or within the normal operating cycle of the business, whichever is longer.

For real estate companies that engage in seller financing, the portion of the notes receivable due within the next year is considered a current asset. This includes any principal and interest payments scheduled to be received during this period. If portions of the note extend beyond one year, those parts are classified as long-term assets. These longer terms reflect the fact that they cannot be readily converted into cash within the standard one-year period.

What Are Liquid Assets? 

It might surprise you to learn that mortgage notes can act as liquid assets. Just like traditional liquid assets trading across various products and services, such as securities or credit accounts held by businesses. Mortgage note holders have the option of converting the promissory note into cash relatively quickly. 

In order to sell a promissory note, you have to find out the note’s value first. A promissory note’s overall value is affected by factors like: 

• Whether the loan is short- or long-term. 
• The level of interest on notes receivable the loan entails. 
• The qualifications of the borrower themselves. The likelihood of receiving payment influences the note’s value. 

You can submit a quote to any reputable mortgage note buyer – like AmerinoteXchange. When you advertise the note online, be sure to include the terms of the agreement, its appraised value and interest rate, and other factors that buyers need to know. 

Understanding the maturity date of notes receivable is also necessary before selling it. Bear in mind that, in general, the risk factor of notes receivable increases as the maturity rate increases. You can expect a better price from a shorter-term note, but an appealing maturity value (the amount the borrower owes upon the maturity date) can make any note enticing. 

Notes Receivable Are an Integral Piece of the Puzzle

Although notes receivable have a lot of potential benefits, mortgage holders need to understand how to manage them well. Knowing how they work is the key to making smarter decisions about your own investment portfolio.