Meet Sarah, a new investor. She saved up a down payment for her first property but dreaded the thought of late-night calls about a broken furnace or chasing down late rent. She wanted the security of real estate without the headaches of being a landlord. Then she discovered a different way to invest: she could be the bank.
Instead of buying property, you can buy the loan attached to it. This strategy is called investing in real estate debt, and it allows you to earn passive income from the property market without ever holding a set of keys. It’s a powerful alternative for investors seeking cash flow over property management.
Table of Contents
What is Investing in Debt?
When you invest in debt, you are buying the right to receive the mortgage payments—principal and interest—from a property owner. You become the lender.
Let’s clear up one thing. You’ll hear “mortgage” and “promissory note” used a lot. The mortgage is the legal document that secures the loan to the physical property, often managed through an escrow account. The promissory note (or just “note”) is the actual “I.O.U.”—the promise to pay back the loan. When you invest in debt, you’re buying that note.
How You Make Money as “The Bank”
As the new “bank,” your profit comes from collecting the payments on the loan you now own. These investments generally come in two distinct flavors.
1. Performing Notes (The “Cash Flow” Play)
A performing note is a loan where the borrower is currently making their payments on time. As the investor, your job is simply to collect that steady stream of income.
- Calculation Example:
Imagine a homeowner has a $200,000 mortgage, possibly through seller financing. A bank might sell you that note for a discount—say, $185,000. You now collect the full mortgage payments on the original $200,000 loan, earning a great return on your $185,000 investment. If the owner eventually sells or refinances, you get the full $200,000 payoff, realizing a built-in $15,000 profit.
2. Non-Performing Notes (The “Fix-and-Flip” of Debt)
A non-performing note is a loan where the borrower has stopped paying. You buy these notes at a deep discount because of the increased risk, often using a hard money approach. Your goal isn’t just to collect payments but to find a resolution, which could mean helping the borrower start paying again or, as a last resort, foreclosing on the property. This strategy carries higher risk but also the potential for a much higher reward.
Four Paths to Get Started in Debt Investing
Getting started can feel overwhelming, so let’s look at four common paths, starting with the most beginner-friendly.
- Real Estate Debt Funds or REITs (Easiest Start): Pool your money with other investors in a professionally managed fund that invests in a portfolio of real estate debt. This is the most passive, “set-it-and-forget-it” option.
- Crowdfunding Platforms (Low Barrier to Entry): Use websites like PeerStreet or Fundrise that connect investors with borrowers. These platforms allow you to invest in fractional shares of loans, often starting with just a few hundred or thousand dollars.
- Private Money Lending (More Hands-On): You act as the direct lender for another real estate investor (like a house flipper) who needs a short-term loan. You have more control over who and what you lend on, but this requires more personal involvement.
- Direct Note Buying (Most Advanced): Purchase individual notes directly from banks, hedge funds, or on specialized online marketplaces. This path offers the most control and potential profit but requires the most expertise and due diligence.
Is Debt Investing Right for You?
This strategy isn’t for everyone. Here’s how to tell if it aligns with your goals.
Debt Investing Might Be PERFECT for You If…
- You prioritize predictable, passive cash flow over chasing huge appreciation gains.
- You want an investment that is secured by a physical asset. Unlike a stock that can go to zero, your investment is backed by real property, which provides a layer of security.
- The thought of dealing with tenants, toilets, and trash makes you want to run for the hills.
You Might Want to AVOID Debt Investing If…
- You’re looking for the massive home-run returns that can come from a hot real estate market. Your return is generally capped at the loan’s interest rate.
- You aren’t prepared for the potential complexity of a loan default, which can sometimes lead to a lengthy legal process.
- You’re unwilling to do your homework. You still need to perform due diligence, which means researching the property’s value and the loan’s terms to ensure it’s a safe investment.
Alternatives to Debt Investing
While debt investing is powerful, it’s helpful to see how it compares to other real estate strategies.
| Investment Type | Primary Goal | Level of Effort | Key Advantage | Key Disadvantage |
| Debt Investing | Passive Cash Flow | Low to Medium | No property management. | No benefit from appreciation. |
| Traditional Rentals | Cash Flow & Appreciation | High | Benefits from both cash flow and property value growth. | Active management required (tenants, maintenance). |
| House Flipping | Capital Gains | Very High | Potential for large, quick profits. | High risk; requires significant capital and market knowledge. |
Common Pitfalls and Limitations
While being the bank is attractive, it’s important to know the potential downsides.
- Default Risk: The primary risk is that the borrower stops paying. While you have a claim to the property, the process of foreclosure can be time-consuming and expensive.
- Limited Appreciation: You do not own the property, so you don’t profit if its value skyrockets. Your upside is limited to the interest and principal payments.
- Illiquidity: A mortgage note is not like a stock that you can sell in seconds. Finding a buyer for your note can take time, making it a relatively illiquid investment.
FAQs: Investing in Debt
What does it really mean to “be the bank”?
When you start investing in debt, you’re stepping into the role of a lender rather than a landlord. Investing in debt means you purchase the loan tied to a property, allowing you to earn from the borrower’s interest payments. Essentially, investing in debt lets you profit the same way banks do—by collecting payments backed by real estate assets.
Is investing in debt safer than the stock market?
For many investors, investing in debt can feel more secure because each loan is backed by a tangible property. While stocks can lose value quickly, investing in debt provides an added layer of protection through the collateralized asset. However, investing in debt still carries risks such as borrower default or property devaluation.
How much capital do I need to start investing in debt?
The amount required depends on your chosen platform or strategy. Crowdfunding sites let you begin investing in debt with as little as $500. If you move toward private lending or buying whole mortgage notes, investing in debt typically requires more substantial funds. Regardless, start small to understand how investing in debt generates passive returns.
What are the main risks of investing in debt?
The biggest risk of investing in debt is borrower default—when the borrower stops paying. While the property secures your investment, recovering it can take time and involve legal costs. Investing in debt also carries liquidity risks since selling a note quickly isn’t always possible. Understanding these before investing in debt helps minimize surprises.
Conclusion
For investors who want the security of real estate without the responsibilities of a landlord, investing in debt is a compelling path. By choosing to “be the bank,” you can generate a steady stream of passive income backed by a physical asset.
