2nd position note - is this a good deal or not?

Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes

Hello all,

A couple of days ago I saw a 2nd position note offered for sale with the following parameters:

Property FMV: $178000
Property location: Illinois
1st mortgage balance: $138000
2nd mortgage balance: $46000
Payment on 2nd: $293
Payment left: 357
Note sales price: $22900
12 months IRR: 14.6%

At first I got excited about 14% return and equity backing the note ($178K-$138K=$40K but the price of the note is $23K, hence $17K equity) but then I did some calculations and found out that the actual ROI is slightly over 5% compounded over ~30 years. In essence, this note has the same payoff as a hypothetical 30yr bond with 5% coupon bought at par value. Not much considering that the interest rates may rise in the next 30 years.

Granted, this note may get refinanced or paid off a lot sooner than 30 years and I heard of average time being ~10 years. That brings expected ROI to 7.8%/year. Still waiting for 10 years until a payoff is a long time.

Another thing I did not like about this note is the property state. It is a judicial state and it takes 12-15 months to foreclose there.

So, here are the questions to the notes investors out there:

What do you think about this note?
Would you buy it or not and why?
Is this note priced too high, too low, or just right?
Is the note term (30 years in this case) an important or minor factor to decide if a note is a good investment?

Thanks
Nick

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Dion DePaoliPro Member

Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes

12y

Originally posted by @Nick B.:

@Dion DePaoli ,

I like the way you calculate returns but what if a note was purchased as a source of income? Then spending it all would leave us with no capital and no note. I guess only interest portion of a payment may be spent and principal may be reinvested.

That whole reinvestment thing only makes sense if it is possible to buy another note with similar characteristics for $280 or so. If no such note is available, one will have to wait until all initial investment is returned (6-7 years) and only then look for another note. An alternative is to buy 100 notes at once and then use monthly income ($28000) to buy 101st note and so forth. Not many people have such resources.

Now, back to the note. If another one like that comes along, would it be a good investment or not so? My main concern is 30 years term. I'd rather see a note with 5 years of payments left but all other parameters being equal.

Do such notes exist?

Nick, I am not sure what other reason you would purchase a note for if not for a source of income/return. They do not make good lawn furniture.

What portion of capital that get's allocated to reinvestment is at the hands of the owner of said capital making the investments. I think what you are asking is what if a portion of the return was needed as some type of personal income to live on. Well, as I mentioned then, the investor can allocate any portion their heart desires between 0% and 100% of the return for such things.

However, the quantification of such things only has meaning to the actual investor and is not so related to the asset. The asset delivers a 14.57% return, what you do with it is your business, in that sense.

The investor capital schedule and the borrower principal and interest schedules only align if the loan is invested in at Par. Any discount or premium applied offsets the investor from the borrower. With discounts, portion of the loan principal becomes return and with premiums portions of the loan interest becomes invested capital in terms of repayment.

Again, at the end of each year, we have $3,336 that is no longer earning return. Is it practical to find investment opportunities with that low of a capital amount around the same return rate as the primary investment? I suppose that is more a function of risk assessment. For instance a second position mortgage might trade for that type of money. Other micro finance opportunities are also out there, you just have to find them. In addition, a linear idea to return is not always practical either. You may only invest the $3,336 in a bank CD and add the entire amount each year earning say 2% until you have done so for 5 years at which time you might be able to invest the $16,680 into a higher return investment which makes up for the time the return was small.

I don't understand the another note question you are asking. A mortgagee does not have to hold the mortgage to maturity. Just as the mortgage was purchased after origination here, so too can the loan be sold prior to maturity. During the term of ownership, you still received return at 14.57% annually. When you 'cash out' will not change that idea.

Are there loans with shorter time to maturity? Yes. Some loans have been written for shorter terms which may or may not have a balloon feature. In addition, as you mention you can simply seek loans with are more seasoned in their total term and closer to the maturity to accomplish the same thing.

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Bill Jacobsen
Salem, OR · Member since 2013 · 701 posts · 159 votes
12y
Your 5% number is only true if you expect to get payments over the next 30 years and put the money under the mattress. What is important is the IRR or MIRR.

Good Luck.

Bill
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Nick B.
OP
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
12y
@Bill Jacobsen,

What about 7.8% if the note is paid off in 10 years? Is this a more realistic number?

What do you think about this note a whole? Is this a good deal or not?

Thanks

Nick
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Jesse Sumner
Real Estate Investor · Tulsa, OK · Member since 2013 · 31 posts · 20 votes
12y
I do not buy or sell notes, but I deal with a lot of foreclosures. You assume that the loan will be paid off eventually. Unless, there is some huge appreciation it does not look like the loan can be refinanced. I live in a judicial foreclosure state also and I view second mortgages as the first looser. Should a foreclosure happen, rarely does anyone bid enough to pay anything on your second mortgage. Therefore, you have to pay off the first mortgage, plus cost, fees and interest to protect your second. You don't say who is selling, but I assume it is an owner carry back. So the buyer does not appear to be financially strong.

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Dion DePaoliPro Member
Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
12y
Nick,

I don't follow your math. Restating:

PMT = $293 (month) / $3,516 (annual)
UPB = $46,000
Yield (49.7% UPB) = 15.09%
ITV = 90.4%
CLTV = 103.4%
Remaining Term = 357 periods (29.75 years)
Note Rate (+/-) = 6.78%

So, this will give off 15% not 5%. Provided all payments are made and on time. It looks like the note rate itself is at 6.78% based on the rounded numbers you gave. I don't understand where you fell into the 5% idea.

The remaining term suggests this loan was modified recently (like 3 months ago).

Is the note a good deal? Well, that is in the eyes of the beholder. Do you understand the risks involved?

You are 90% Investment to Value. If the borrower makes payments you will do nicely with 15% return. If the borrower defaults there is a 10% cushion or about $18k which can be advanced and possibly recovered which provides 'some' working room. I am not a huge fan of second liens but I would be curious what happened with the first lien here as well as the second. If the first lien filed for FCL or was modified as well, I would want to take that into consideration. If you as a 2nd lien holder are defaulted on, you may be able to squeak by and not loose money if the borrower maintains the first. In contrast, if they default on both of you, advances on the account will quickly erode the cushion in equity and start eating away at your capital investment.

Figure you have to be invested in this for about 7 years in order to have been paid back your initial investment through borrower payments. Any early stage refinance will boost your return. That said, a modification 3 months ago and a property with no equity doesn't warrant a refinance anytime soon. BTW, as far as the 10 year return, I come up with about 18.34% as $6,736k +/- will be paid down in principal.

Again, being a first lien type of guy, I am not sure I would bite on this one. It does have it's attractiveness though. My knee jerk reaction is the discount is not enough. I think I would want a price around $18k to $15k depending on some specifics of asset information. That would put the return around 23% and give an additional $4k+ in equity cushion which might feel a little more comfortable for the risk vs return ratio to me.

Foreclosure time does not spook me. The asset should be priced correctly to accommodate this feature. Long investment term does effect time value of money, but the bigger elephant most of the time is the added expenses due to time. With proper equity cushion that can be mitigated and even in a FCL a decent return can be achieved.
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Nick B.
OP
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
12y
Originally posted by @Jesse Sumner:
I do not buy or sell notes, but I deal with a lot of foreclosures. You assume that the loan will be paid off eventually. Unless, there is some huge appreciation it does not look like the loan can be refinanced. I live in a judicial foreclosure state also and I view second mortgages as the first looser. Should a foreclosure happen, rarely does anyone bid enough to pay anything on your second mortgage. Therefore, you have to pay off the first mortgage, plus cost, fees and interest to protect your second. You don't say who is selling, but I assume it is an owner carry back. So the buyer does not appear to be financially strong.

The note was offered by PPR if that makes any difference. I am well aware about 2nd positions being losers in foreclosure but this note had a theoretical equity in it. That's why it piqued my interest.
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Dion DePaoliPro Member
Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
12y
Originally posted by @Nick B.:

The note was offered by PPR if that makes any difference. I am well aware about 2nd positions being losers in foreclosure but this note had a theoretical equity in it. That's why it piqued my interest.

I believe PPR offers a warrant on the performance of the note. That would be a plus in scheme of things. In that setting, PPR is offering a decent deal since a default would be purchased back by them and they would replace you with the 15% yield (or so I believe). That warrant would lower the risk to the investor.

That is one of the best features (that I know of) of the PPR offerings. I would still try for some more yield initially but I could also understand if PPR stands firm on the price.
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Nick B.
OP
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
12y
Originally posted by @Dion DePaoli:

Originally posted by @Nick B.:

The note was offered by PPR if that makes any difference. I am well aware about 2nd positions being losers in foreclosure but this note had a theoretical equity in it. That's why it piqued my interest.

I believe PPR offers a warrant on the performance of the note. That would be a plus in scheme of things. In that setting, PPR is offering a decent deal since a default would be purchased back by them and they would replace you with the 15% yield (or so I believe). That warrant would lower the risk to the investor.

That is one of the best features (that I know of) of the PPR offerings. I would still try for some more yield initially but I could also understand if PPR stands firm on the price.

Yes, the warranty would also help but up to a point. They refund the difference between the original note price and sum of all payments received. So, if the borrower defaults in 1st year, the note holder would lose all interest for that year but keep the principal. If the borrower defaults after enough payments have been made to recoup initial purchase, then the warranty makes no sense.

Now, how I arrived to 5%:
Initial investment: 22900
Sum of 357 payments of (293-15): 99246 ($15/mo is charged by FCI to service the note)

Annual interest rate: 1-((99246/22900)^(1/29.75)) = 0.0505 or 5.05%

Here is a screenshot from a calculator (http://www.pine-grove.com/online-calculators/roi-calculator.htm)

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Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
12y
In most cases the seasoning of 3 months would be considered too short (and that might still apply). PPR has done some type of mod so this is a "rehabbed" or reworked note; how much benefit the borrower got in that mod could be the big factor in whether they will be both willing and able to pay.
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Wayne Brooks
Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
12y
Nick, I think the yield problem you're having is that you ROI calculator is calculating the yield as a lump sump at the end of 30 years, as opposed to monthly payments. Using your net (after servicing fee), the APR is about 14.375%, with no early pay offs.
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Nick B.
OP
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
12y
Originally posted by @Wayne Brooks:
Nick, I think the yield problem you're having is that you ROI calculator is calculating the yield as a lump sump at the end of 30 years, as opposed to monthly payments. Using your net (after servicing fee), the APR is about 14.375%, with no early pay offs.

Yes, it's 14.375% based on diminishing principal. I was just trying to see what interest rate would be required to reach the same payoff over 30 years.
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Dion DePaoliPro Member
Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
12y
Well, I wouldn't use that calculator any more.

Purchase Price = $22,900
Gross Payments (annual) = $3,516
Annual Servicing Fee = $180
Net Payments (annual) = $3,336
Payment Yield = (3,336/22,900) = 14.57%

Life Time Payments = $104,601
Life Time Service Fee = $5,355
Life Time Net Payment = $99,246

PV of $293 over 357 periods at 6.78% interest = $44,919. The difference is likely due to the Loan Amount and Rate being calculated based on your rounding. Periodic payments may not always pay to zero.

So, the payment of $293 at 6.78% pays the loan to zero (for the most part) in 357 periods. The loan will produce roughly $61,738 in interest based on that rate. So the total payments made are $107,738 gross or $103,343 net and the Net Profit is $73,844 which is 322% ROI.

Again, the difference in Life Time Payments (293 x 357) and Total Paid (Total Interest + Total Principal) are a little off from rounding.

The IRR of this deal:

P(0) (-22,900)
P(1) 3,336
P(2) 3,336
P(3) 3,336
...
P(29) 3,336

IRR = 14.26%

Now, how I arrived to 5%:
Initial investment: 22900
Sum of 357 payments of (293-15): 99246 ($15/mo is charged by FCI to service the note)

Annual interest rate: 1-((99246/22900)^(1/29.75)) = 0.0505 or 5.05%

The above is not correct. The annual rate would not be the lifetime divided into the investment and then raised to the number of years.

= (1 + (278 / 22,900)) ^ 12 - 1 = 15.58%

That will be less accurate than a full IRR over all periods since we are finding the period return (1.21%) and raising it to the loan term, so time discounting is not occurring.

As far as that web page goes, it simply is not correct. I would not use it any more. Try excel or a calculator.

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Joshua Andrews
Lender · Austin, TX · Member since 2012 · 211 posts · 166 votes
12y
I'm glad I saw this thread. I can see how this subject gets easily confused. I've been looking at note returns, with a focus on IRR. However I am also looking long term and calculating how compounding will affect my retirement given certain basic cash on cash returns.

Speaking strictly about note income, it's my understanding that IRR accounts for the time value of money including principal and interest portion of the payment. Naturally the amortization schedule is not constant with regards to how much of the payment is principle and how much is interest.

So, I'd like to ask if my assumptions are correct using the above example. For a basic cash on cash return here is my understanding of the above example. Please correct me if I'm wrong or a better more efficient way to do this.

Using above example:

Purchase Price = $22,900
Gross Payments (annual) = $3,516
Annual Servicing Fee = $180
Net Payments (annual) = $3,336
Payment Yield = (3,336/22,900) = 14.57%

Life Time Payments = $104,601
Life Time Service Fee = $5,355
Life Time Net Payment = $99,246

$99,246 - $22,900 = $76,346 actual profit over life of loan

So taking $76,346 and dividing over 357 periods we get $213.85

$213.85 x 12 months = $2,566.25 per year total PROFIT return. I realize this is not even each year and is only an overall return if the loan follows to the end of amortization.

So $2,566.25 per year / the purchase price of $22,900 = 11.20% cash on cash return.

Is this a correct assumption, or is there a better way to figure out cash on cash? I realize IRR is more important. The reason I'm looking at cash on cash is to do projections in a compound interest calculator over long periods of time to see what my actual cash flow PROFIT will be.

Is this correct or is there a better way to do this?

Thank you!

Josh
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Dion DePaoliPro Member
Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
12y
@Joshua Andrews

IRR is the more accurate measurement. Calculating the free cash idea, which you called cash on cash becomes less meaningful and can be misleading idea.

Essentially what you are saying is, the IRR = 14.57% of which I choose to allocate 3.37% to pay back/down the invested capital. Since, what you describe with the 11.20% is essentially 'free cash flow' or cash flow that you can allocate at will to an additional investment or to pay down capital demands. It has to be a part of the overall return rate, since you have to get it to allocate it.

The target of your inquiry however is still the entire 14.57%. Since you decide to pay the capital back at 3.37% and assuming you are the capital investor, you still end up with all of the 14.57% in your pocket to reinvest. Otherwise, you have a balance of capital (11.20% portion) which is being reinvested and a balance of capital (3.37% portion) not being invested.

In the event you were managing other people's capital, the above allocation, which commonly gets referred to as a waterfall will dictate what is mandated to be paid from the total return, which then leaves essentially 'free' cash to reinvest. But that is really the only time breaking the two numbers apart has any real meaning. Again, in the event you are the only investor and manager in the mortgage asset, the entire amount of money gets paid to you, which is 14.57% of which ALL of it would be subjected to compounding, not just a portion.

To say it one more time a different way, anyway you slice it the ANNUAL remittance to you is still $3,336. If you use 76.87% of the annual funds, which is the 11.20% portion or $2,564 to reinvest, you will have the 3.37% or 23.13% of the annual funds left over not compounding which is about $772 per year.

Since YOU are the investor and it is YOUR capital all monies still flow back to you. So the $772 or (3.37% portion) is still money you get annual. Why would you not reinvest those dollars too?

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Nick B.
OP
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
12y
@Dion DePaoli ,

I like the way you calculate returns but what if a note was purchased as a source of income? Then spending it all would leave us with no capital and no note. I guess only interest portion of a payment may be spent and principal may be reinvested.

That whole reinvestment thing only makes sense if it is possible to buy another note with similar characteristics for $280 or so. If no such note is available, one will have to wait until all initial investment is returned (6-7 years) and only then look for another note. An alternative is to buy 100 notes at once and then use monthly income ($28000) to buy 101st note and so forth. Not many people have such resources.

Now, back to the note. If another one like that comes along, would it be a good investment or not so? My main concern is 30 years term. I'd rather see a note with 5 years of payments left but all other parameters being equal.

Do such notes exist?
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Account Closed
Dallas, TX · Member since 2013 · 4k+ posts · 744 votes
12y
If there is a 1st non performing note what make you think you can get the 2nd non performing note to re-performing. The best thing is to buy a 1st non performing note and foreclosure on it, and you will make a good payday.

Joe Gore
1 Reply
Ellis San Jose
Specialist · Westlake Village, CA · Member since 2010 · 1k+ posts · 781 votes
12y
@Nick B.

If you are purchasing notes for the purpose of predictable monthly income, non-performing 2nd's with high CLTV% are probably not the most suitable investment.

Also, I am glad you are getting some help here from some pro's on your calculation errors.

Take more time to understand how to calculate time value of money equations. It is essential for smart note investing. I like the HP 10BII (there is also a great 10Bii app for my iPad that I use daily).

To answer your question about are there notes with 5 years of payments left. There are virtually an infinite number of notes that either exist, that can be created, or that can be modified.
1 Reply
Joshua Andrews
Lender · Austin, TX · Member since 2012 · 211 posts · 166 votes
12y
@Dion DePaoli

Thank you for the excellent feedback. I understand the point your getting at. What I was referring to is in the simular vein of what Nick B just mentioned.

Basically figuring out how much of the note proceeds could be used as spendable income (like at retirement) without eating into my principal. That's more of the idea I was getting after.

Your absolutely correct on the 14.57% being compounded which is something I had not considered fully. Appreciate your posts and learning a lot here, thank you.

Josh
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Nick B.
OP
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
12y
Originally posted by @Ellis San Jose:
@Nick B.

If you are purchasing notes for the purpose of predictable monthly income, non-performing 2nd's with high CLTV% are probably not the most suitable investment.

Ellis,

The note I posted here was performing (or re-performed to be precise). Where did you get non-performing reference?

As for my calculations, I was just trying to see what kind of rate should I get on a CD (compounded annually) to match total return of a given note at the same maximum period of time (29.75 years).

Obviously notes and CDs are different but if we start with the same initial investment and arrive at the same ROI in the same period of time, the rate of return is the same, isn't it?

14% on a note is non-compounded. Try to compound it over 30 years and see what the payoff would be :-)
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Nick B.
OP
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
12y
Originally posted by @Account Closed:
If there is a 1st non performing note what make you think you can get the 2nd non performing note to re-performing. The best thing is to buy a 1st non performing note and foreclosure on it, and you will make a good payday.

Joe Gore

Sure thing, Joe. Are you going to show some real examples of how that works? I'd like to see actual documents and court records.

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Dion DePaoliPro Member
Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
12y
Originally posted by @Nick B.:
@Dion DePaoli ,

I like the way you calculate returns but what if a note was purchased as a source of income? Then spending it all would leave us with no capital and no note. I guess only interest portion of a payment may be spent and principal may be reinvested.

That whole reinvestment thing only makes sense if it is possible to buy another note with similar characteristics for $280 or so. If no such note is available, one will have to wait until all initial investment is returned (6-7 years) and only then look for another note. An alternative is to buy 100 notes at once and then use monthly income ($28000) to buy 101st note and so forth. Not many people have such resources.

Now, back to the note. If another one like that comes along, would it be a good investment or not so? My main concern is 30 years term. I'd rather see a note with 5 years of payments left but all other parameters being equal.

Do such notes exist?

Nick, I am not sure what other reason you would purchase a note for if not for a source of income/return. They do not make good lawn furniture.

What portion of capital that get's allocated to reinvestment is at the hands of the owner of said capital making the investments. I think what you are asking is what if a portion of the return was needed as some type of personal income to live on. Well, as I mentioned then, the investor can allocate any portion their heart desires between 0% and 100% of the return for such things.

However, the quantification of such things only has meaning to the actual investor and is not so related to the asset. The asset delivers a 14.57% return, what you do with it is your business, in that sense.

The investor capital schedule and the borrower principal and interest schedules only align if the loan is invested in at Par. Any discount or premium applied offsets the investor from the borrower. With discounts, portion of the loan principal becomes return and with premiums portions of the loan interest becomes invested capital in terms of repayment.

Again, at the end of each year, we have $3,336 that is no longer earning return. Is it practical to find investment opportunities with that low of a capital amount around the same return rate as the primary investment? I suppose that is more a function of risk assessment. For instance a second position mortgage might trade for that type of money. Other micro finance opportunities are also out there, you just have to find them. In addition, a linear idea to return is not always practical either. You may only invest the $3,336 in a bank CD and add the entire amount each year earning say 2% until you have done so for 5 years at which time you might be able to invest the $16,680 into a higher return investment which makes up for the time the return was small.

I don't understand the another note question you are asking. A mortgagee does not have to hold the mortgage to maturity. Just as the mortgage was purchased after origination here, so too can the loan be sold prior to maturity. During the term of ownership, you still received return at 14.57% annually. When you 'cash out' will not change that idea.

Are there loans with shorter time to maturity? Yes. Some loans have been written for shorter terms which may or may not have a balloon feature. In addition, as you mention you can simply seek loans with are more seasoned in their total term and closer to the maturity to accomplish the same thing.
2 Reply
Account Closed
Dallas, TX · Member since 2013 · 4k+ posts · 744 votes
12y
@Nick B.

Why don't you spend a few $$$ and let Mr. Horn teach you and answer all your questions on 2nd non performing notes it will help you understand everything?

Mr. Horn is a regular posted here on BP.

Joe Gore
0 Reply
Nick B.
OP
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
12y
Originally posted by @Dion DePaoli:

I don't understand the another note question you are asking. A mortgagee does not have to hold the mortgage to maturity. Just as the mortgage was purchased after origination here, so too can the loan be sold prior to maturity. During the term of ownership, you still received return at 14.57% annually. When you 'cash out' will not change that idea.

Are there loans with shorter time to maturity? Yes. Some loans have been written for shorter terms which may or may not have a balloon feature. In addition, as you mention you can simply seek loans with are more seasoned in their total term and closer to the maturity to accomplish the same thing.

Dion,

Thank you for your answer. The reason I am concerned about loan maturity is more psychological than rational. 30 years term is a worst case scenario and I don't want to get stuck in it even hypothetically.

I had a 30 years mortgage which I paid off in less than 10 years primarily out of fear. What if I lose a job and could not pay and get foreclosed, etc.? But that's me. I doubt that majority of borrowers are the same though. Hence, the shorter term - the better. A lot less crap may happen to a borrower in 5 years vs. 30 years :-)
0 Reply
Nick B.
OP
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
12y
Originally posted by @Account Closed:
@Nick B.

Why don't you spend a few $$ and let Mr. Horn teach you and answer all your questions on 2nd non performing notes it will help you understand everything?

Mr. Horn is a regular posted here on BP.

Joe Gore

What does it have to do with Mr. Horn? I don't know him and have no questions about non-performing notes. I am not looking for non-performing notes, 1st or 2nd. This thread is about a performing note.
0 Reply
Account Closed
Dallas, TX · Member since 2013 · 4k+ posts · 744 votes
12y
Sorry please carry on.

Joe Gore
0 Reply
Dion DePaoliPro Member
Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
12y
Originally posted by @Nick B.:

Originally posted by @Dion DePaoli:

I don't understand the another note question you are asking. A mortgagee does not have to hold the mortgage to maturity. Just as the mortgage was purchased after origination here, so too can the loan be sold prior to maturity. During the term of ownership, you still received return at 14.57% annually. When you 'cash out' will not change that idea.

Are there loans with shorter time to maturity? Yes. Some loans have been written for shorter terms which may or may not have a balloon feature. In addition, as you mention you can simply seek loans with are more seasoned in their total term and closer to the maturity to accomplish the same thing.

Dion,

Thank you for your answer. The reason I am concerned about loan maturity is more psychological than rational. 30 years term is a worst case scenario and I don't want to get stuck in it even hypothetically.

I had a 30 years mortgage which I paid off in less than 10 years primarily out of fear. What if I lose a job and could not pay and get foreclosed, etc.? But that's me. I doubt that majority of borrowers are the same though. Hence, the shorter term - the better. A lot less crap may happen to a borrower in 5 years vs. 30 years :-)

I understand what your driving at. I guess one other mental suggestion is stop trying to treat the mortgage investment like a fixed income bond. In a bond investment principal is returned at maturity. In a whole loan investment principal is returned periodically with the payments.

So based on that idea, when the loan prepays (pays to zero prior to maturity) "the rest" of your capital investment is returned to you. That doesn't change what you earned project to date. So If I buy into a loan and hold it for say 5 years which earns a 12% yield and then I sell it my return is what I collected over the term of my ownership.

I think the mental barrier is for folks to try and treat whole loans like real property. It is not. In that sense, real property is more like a fixed income bond. The invested capital amount is returned at the END of the investment. In whole loans the invested capital is returned DURING the investment.

Examples:

Real Property:
Buy: $100
Sell: $110
Rent Income: $5
Profit: $15 ($5 during and $10 in the end)

Whole Loan:
Buy: $100
Sell: $80
Total Payments: $25 ($20 principal plus $5 interest)

(I made these numbers up)

So in the idea of the whole loan, technically speaking the longer you hold the loan, the less you will Sell the loan in relation to what you purchased it for. Since the principal and capital portion of the loan is returned through the payment stream. The principal balance decreases over time because it is actually paid down.

Under that same idea, to point to a flaw in your investment term plan/idea. In the example used in this thread, if you allocate 100% of all the payments made you will have all of your capital back in 7 years. So you have 23 years of pure profit then. We are 2 years off from your target term.

If you think of it that way, the loan will have paid over $22,900 in those 7 years ($25,138.93 or $4,217 principal and $20,921 interest) The principal balance of the loan will have only been reduced by the $4,217. So, at that point, you have $41,782 in principal (UPB) plus the potential interest of $41,053. At that moment, when you have been paid all the invested dollars back, you will realize a $41,782 gain (provided the loan pays to zero and not default). This is what we would expect frankly based on the IRR at 14.57%. Around 1.8% times on our money, so almost doubled twice.

The asset returns 14.57% to maturity, what is done with those proceeds once received is up to the investor. The manners in which it can be treated are pretty numerous.
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