When an entity purchases another entity’s assets, a number of documents must be signed and delivered. Two of the most significant documents are the sale contract and the promissory notes (e.g., the promissory notes). A sale contract is a legal agreement between two parties concerning the transfer of ownership of one party’s assets to the other. Promissory notes are promises made by one party to pay a certain sum of cash to the other party.
One of the most common questions that I get from sellers is why a seller receives less than the full face value when he sells a bond. After all, they reason, the buyer pays back the entire principal plus the interest. And they want to know the average discount rate.
There are several key factors that we take into consideration when valuing and discounting notes.Credit of the payerProperty type (residential, commercial etc.)Location of property (location, neighborhood, urban versus rural).Amount of down paymentThe amount of equity in the property is the amount by which its market price exceeds the sum of the outstanding mortgages and liens against it.Condition of the propertyRate on the NoteTimeliness of payments
Why A Discount?
When an investor buys a home through us, they can expect to receive a thorough inspection report showing any major issues with the property. They also get access to our full notes database so they know exactly what type of loan they are purchasing. Our investors typically do not buy just one home; instead, they invest in multiple properties throughout the country. So, when an investor buys a home, they are buying into a system where they can make more profit over time.
If the property owner has a high credit score, then he/she may be able to qualify for a lower mortgage loan. However, if the borrower defaults on his/her mortgage loan, the lender will probably charge him/her an extra fee called “private mortgage insurance” (PMI). PMI protects the lender against losses from borrowers who default on their mortgages.
We don’t usually buy notes with the intent of foreclosings them, but we must realize that it may be our last resort when all other options have failed. Foreclosure on a property takes a lot of effort and expense, and the note buyer isn’t making any money during the process.
These factors add up to more risks for investors. The discounts reflect these risks.
When asking what the average discount rate is, we don’t mean an average across all purchases. Instead, we’re talking about a typical discount rate for each type of note. For example, if most people get discounts between 75 and 90 percent, then you would expect the average discount rate to fall within that window too.
Suppose you had an outstanding loan of $100,000 for which six monthly installments were due. You made the first payment of $739.68 and then missed four subsequent payments. Now suppose you miss another three consecutive payments. What happens if you pay off the remaining loan principal of $97,541 before missing any further payments?Scenario # 1Scenario #2Sales price$150,000$105,000Down payment$50,000$5000Original note amount$100,000$100,000Credit score of payer700600
Clearly, the situation in #1 is less dangerous than #2 because there were greater initial investments and the payee had better credit scores. For the borrower, this means that the lender is less likely to fail, and that there is ample equity in the property if the loan defaults. On #1, however, the borrower may choose to accept a lower interest rate (6%) rather than take a larger amount of money upfront. In this case, the borrower would only be willing to pay $85,824 for the remainder of the mortgage. On #2, the borrower might agree to pay a higher interest rate (8%), resulting in an overall cost of $76,036.
There are several benefits to selling a mortgage loan despite the fact that a lender must take a discount for accepting an unsecured loan.Being able to pursue new investment optionsHelping simplify the finances for heirs of a deceased person’s estatesnot having to pay for property taxes, insurance, or repairs on the propertyDon’t worry so much if you don’t get paid every month.
Selling a note can be a good way to get some quick money right now. But don’t expect too much from it. Make sure you’re realistic about the price of the house and the price of your note, and things will run much smoother for you.