Buying Newly Created Notes at a Discount – Smart Play or Red Flag?

Question

d I’ve noticed some sellers offering deep discounts on newly created notes. For example: a $50k note originated just a few months ago being offered at $40k. The notes are “performing,” but in some cases, there’s little or no payment history yet.

On the surface, I understand they may just be looking to free up capital for another deal. But it got me thinking:

- Is this a common and sustainable strategy for sellers?

- Or is it a red flag when someone is consistently offloading brand-new notes at a discount?

- For buyers, what’s the right way to weigh that lack of seasoning against the discount?

Curious how the more experienced investors here evaluate these situations.

Dan Deppen · Answer

To try to keep from writing a novel, I'll give some of my comments on this topic in bullet points:

-As others have said, its not uncommon for newly originated notes to sell at a discount

-The quality and value of new notes values widely. "wild west" crap paper could sell anywhere from a huge discount to not being sellable at all. On the other end of the spectrum some investors create what is basically bank grade paper, and I've seen new seller finance loans sell for up to 102% of UPB.

-There is no consistency among "seller finance notes", you need to look at each one individually. Look at borrower credit, down payment, and how it was originated. Did they use an RMLO and is it compliant with TRID / Dodd Frank / etc?

-If they used an RMLO to originate it, did they use a good one? I recently reviewed an underwriting package from another RMLO. They told the investor / lender it was a solid borrower and their DTI was 27%. When I went through the details their DTI was actually 68%. Plus the way they calculated the income using bank statements was suspect at best, so the DTI may have been 100%.

-If its a high quality loan (good credit, strong down payment, selling price makes sense, etc), then you don't need a pay history. The borrower's past history with other credit lines and their skin in the game is giving you this information.

-If the loan is not top tier (maybe sketchy credit, low down down payment, but still Dodd Frank compliant), then having some seasoning can become important.

-Watch out for notes where the seller inflated the price. There is a strategy out there to buy cheap properties and mark them up, and get unsophisticated borrowers who are comparing their monthly payment to rental rates. For example, buy a $50K property off the MLS and then sell it for $85K with no improvements. Even if the borrower has reasonable credit and can afford the loan these are super high risk.

So to sum this up, a new note selling at a discount isn't a red flag in and of itself. The key is to understand the value of the note so you know what its worth and if there should be a discount or not, and if so how much.

Alecia Bolton · Answer

Yes, it's fairly common that freshly created loans are sold at a discount.  The risk is no pay history, so you're looking at how the originator underwrote the borrower and the asset.

The reason they do this is because they typically are getting an origination fee, and they make their money on the churn, so they can afford to offer the discounts.  I speak of folks who do private lending as a business.  They are also usually selling non-owner occupied/flip notes.

If it's a one-off, and the originator is selling a seller financed note...then they may not care about the discount because their cost-basis is already low.  Or it could be that the underwriting is crap.  Those are the ones you look a little more closely into.

Jamie Bateman · Answer

Adding on here (some above have mentioned some of this), for many owner-occupied note sellers, the strategy is to acquire a property at a steep discount, then seller-finance the property at a price much higher than what they paid to obtain the property. They receive the property buyer's (borrower's) down payment as well as the funds from the note buyer. These two lump sumps give them a profit and $ to repeat the process. There are both honest and shady people who operate with this model.

In the business-purpose space (bridge, fix-n-flip, etc.), the profit center is more about points and other $ received up front on the new loan. And they may have lines of credit that provide lower cost of capital and flexibility. So selling at a discount still may make sense.

Chris Seveney · Answer

very common

Bruce Lynn · Answer

Buy a property for $20,000, sell it for $100,000 with $80,000 note.  Sell the note for $72,000.  I expect probably people do this every day.  If the note is a few months old, why are their no payments?  I would think on most notes you would have at least interest payments those first few months.  While I am sure there are exceptions I would also think most people want to see a couple of payments before they buy....that 60 day idea?

Richard Dickson · Answer

Good point — the lack of even a couple months’ worth of payment history does raise questions. I’ve heard the “60-day rule” mentioned too, where having at least a couple payments on record makes buyers more comfortable. Definitely something to keep in mind when looking at newly originated notes being sold so quickly.

Buying Newly Created Notes at a Discount – Smart Play or Red Flag?

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