Is the sticker shock just too much when discounting notes?
It might be time to consider selling just some of the remaining payments.
Note buyers have long used the partial purchase to reduce their exposure or investment risk, but it also has benefits for the seller.
You see the time value of money makes payments due now more valuable than those further out in the future. The partial purchase takes advantage of this by letting the seller cash in the most valuable portion – the more immediate payments. Plus the seller gets to keep the face rate or interest rate on the Promissory note working for them on the portion they hold.
Take a look at how this works by contrasting examples of a full purchase and partial sale.
Note Buying Example #1 – The Full Offer
Consider a transaction with a balance of $100,000 at 10% interest with 360 payments of $877.57 per month. If the investor desires an 11% yield, the pay price will be $92,150.55.
- Current Balance: $100,000.00
- Cash at Closing – Full Offer: $92,150.55
- Discount: $ 7,849.45
Note Buying Example #2 – The Partial Offer
Now compare what happens if the seller elects to assign just half of the remaining cash flow – the next 180 monthly payments. The investor can pay $77,210.31 at an 11% yield for the right to receive an amount equal to 15 years of payment.
Compared to the full offer in the first example the initial cash to the seller at closing is reduced by $14,940.24 … but look at what the seller retains!
When the mortgage or deed of trust is assigned back to the seller in 15 years, the principal balance still owed by the payer will be approximately $81,665.21. The seller defers payment of the $14,940.24 in exchange for a balance of $81,665.21 in 15 years!
- Current Balance: $100,000.00
- Cash at Closing – 180 Partial Purchase: $77,210.31
- Plus Remaining Balance in 15 years: $81,665.21
- Seller Receives Over Time: $158,875.52
Keeping It Real
You may have seen note buyers advertise:
“No Discount” or “We Pay Full Face Value”
In reality they are likely using some sort of partial purchase similar to the prior example.
There is a sum of cash at closing for the partial purchase and then the balance is reassigned to the seller in the future, with the two combined amounts equaling or exceeding the principal balance at closing. This might also be structured as a two-stage buyout with cash at closing for the first partial stage, with another advance in the future for the seller’s remaining interest or the second stage.
While “No Discount” is an eye catching marketing phrase, it can also be misleading to the seller as they aren’t truly receiving 100% of the balance at closing. Rather it is received in stages over time.
In order to avoid any confusion or misrepresentation, avoid using these marketing slogans and just present the options as partial purchases with money now and money later.
It’s also important to know the future payout can be impacted if the payer stops making payments or pays off the balance early. These provisions are outlined in the purchase agreement and should be reviewed carefully with a trusted legal or tax adviser.
Searching for more ways to buy and sell mortgage notes, including sample partial agreements? Be sure to check out the Personal Profit Series now available in owner financed resources.
With intrerest rates being at an all time low doesn’t this make seller financed mortgage notes higher in value? And it seems most investers I work with want the notes to have out ragely rates of 8 % to 12 % and so on. And seem to balk at anything with 4.25 and 6% and so forth . They seem to want notes tha are almost impossible to find, as most people will not charge this much in intrest because most home buyers will simply not pay the high intrest rate.
Hello Howard! Great question and the answer is tied to the current State of the Note Industry. I believe you will find this article helpful:
https://noteinvestor.com/notes-101/note-business-state-of-industry/
Most investors are pricing based on risk and market conditions. This could mean a lower ITV (investment to value) or a higher yield requirement both of which impact the purchase price. Most investors will still buy the lower face rate notes but will still want their higher yield which results in a higher discount. This is why the partials can really help get the seller access to cash now without selling or discounting the whole note. They can then look at selling more payments when the note has more seasoning and equity and/or the market conditions have improved.
One question if you have time
When an investor buys the payments and half the balloon
does the other half of the baloon revert to the seller?
Thanks
Tom
Hello Tom,
Yes, the remaining portion would be paid to the seller when the payer makes the balloon payment. This is outlined in the Partial Purchase Agreement which spells out all the terms and conditions. The portion that the seller retains and does not sell is often referred to as the remainder interest. We always suggest a seller has their attorney or legal counsel review the partial documents before entering into any form of legal agreement.
Thanks for reading and commenting at Note Investor!
Tracy