If you were to buy a $20,000 mortgage note, 15-year term, 8% interest, how would you determine the price? Would you pay $20,000? Or, would you pay less? If your investment strategy was to have each invested dollar earn 13%, you couldn’t buy that note for “full price,” since you would only be earning 8% interest.
To get your 13% return or yield, you would have to pay less than the $20,000. This is the concept of discounting mortgage notes. Though you pay less for the note, the monthly payments won’t change. They’ll still be $191.13 each month. So, the question really is: If you’re receiving payments of $191.13 for 15 years, how much must you pay to get a 13% yield?
First calculate the parameters of the original note:
Calculate the Pmt
|This is the note you are buying.|
We want to calculate the Present Value of this note at our required yield. We put the yield in the I/Y register and then calculate the PV.
Calculate the PV
|The PV is the amount you will pay for this cash flow to get a 13% yield.|
Answer: PV = $15,106.20. By paying $15,106.20 for this stream of payments, you will have a yield of 13% per year. You would present this offer to the seller of this note.
|What You Have Learned: Discounting means raising your “yield” in the I/Y column and calculating the PV or Present Value to find the price you will pay for the note.
Box #1: Pmt = $191.13