When, how and why to to Discount a Mortgage
The ability to increase the yield on a mortgage by buying it a below face value is a good way to make money quickly and safely. The concept of mortgage discounting if widely used in the real estate industry and the the world of institutional banking and also goverment loan programs as well as the private sector.
Definition
A discounting of mortgage occurs when the holder of the mortgage sells the note to either a third party or the maker for an amount less than the current amount owed. This current amount would be the combined total of oustanding principal plus unpaid interest owed. The result is that the buyer would upon, satisfaction of the the note at its contract rate and terms, receive a higher yield than the original holder. We can illustrate this with an example.
Bob sold his apartment building four years and took back a second mortgage in the amount of $50,000. The mortgage called the interest only payment is payable at 10% for ten year, with a balloon payment of the oustanding principal due at the end of the tenth year. The loan has 6 years left and Bob would like to make another investment. Richard comes along and says he will give Bob $40,000 cash for the loan. If Bob accepts this offer, bob has discounted the second mortgage to Richard. Richard is not getting $5,000 per year (this is the interest only payments which were 10% on rhw original face amount of the loan.) however since these payments are calculated on a purchase price of $40,000 the yield returned on invested capital is 12.5%. But dont forget when the loan is paid off in severn years or possibly sooner, there will be another $10,000 bonus because the payoff is based on the original face amont of the loan, which was $50,000. Since Richard only paid $40,000 that bonus moves the average yield p. The real bonus would come if the mortgagor of hthis second mortgage wanted to refinance his first mortgage 12 months after Richard purchased the mortgage. The payoff would be one year of interest. $5,000, plus the hold face amount of $50,000 or $55,000 in all. this is a return of $15,000 (interest plus bonus) on the $40,000 investment. The actual yield in this example would be 37.5% interest.
