If you can use a financial calculator, you have a very powerful tool for making profits when buying both discounted notes and real estate. We recommend either the Texas Instruments BA II+ or the Hewlett Packard 10b. Both are only about $30. You can easily solve the problems below with either calculator.
Here’s a “twist” on buying a note. One writer says he has been using this idea instead of loaning on your note. He does a pawnshop loan. Here is an example: Recently a developer called up and asked how much we would give him for the following 2nd note which had been seasoned for only
4 months. Here’s the note:
This is an interest only note. Clear your calculator. Calculate the Pmt
After giving him an offer of $51,528.26 (I required a 25% yield), he balked and said the discount was too large for a $100,000 loan. I tried talking him into a partial, but he didn’t understand it. He then told me he only needed $50,000 to carry a few of his remaining houses that were for sale. He figured he would have them all sold within one year. So, I gave him the following solution:
I would purchase his $100,000, 2nd note for $50,000 (PV) and give him an option to buy it back anytime within the next 18 months (N) for $54,500 (FV). In other words, he could borrow $50,000 from me now and repay $54,500 in 18 months. The $4,500 in interest is only a 6% annual rate for the $50,000 loan. ($4,500 interest ¸ $50,000 loan = 9% for 18 months or 6% for 12 months.)
The note is collateral for my loan, of course. Here’s my yield from my point of view:
Calculate the I/Y if it is not repurchased:
This arbitrary $54,000 balloon payment seems fair to the note seller.
I pay out $50,000 and get all the Pmt and FV for a 25% yield—if the note is repurchased for $54,500 in 18 months.
The note seller liked this idea because it appeared to be just a very small discount. It was good for me, because it limited my exposure in the property and did not tie up my money for too long. If he buys the note back before the 18-month term is up, my yield goes up. If he does not buy the note back within the 18-month term, I still achieve at least a 25% yield.
Calculate the I/Y if the note seller does not buy it back and it goes to the full 80 month term (N):
If the note goes to term, this is the yield to the note buyer.
I prefer to use full purchases with this buy-back option rather than a partial purchase because:
1.) It is cleaner, 2.) The courts understand full purchases and options, but partial purchases still have not really been tested in the courts 3.) I do not have the “potential” problem with a double foreclosure—one on the seller and one on the payor.
What You Have Learned: A “Buy Back” option covers up a huge yield and may not even be exercised by the note seller.
Box #1: Pmt = $833.33; Box #2: I/Y = 25.01%; Box #3: I/Y = 25.76%