This week we're going to see how much we can pay for a note to hit our yield target, and how to push that yield even higher!
THE SCENARIO:
Let's take a closer look at ways I could buy a note. Like most bigger-ticket items, notes often have prices that are negotiable - you just have to know that you can offer something other than the asking price, and away you go.
First off, I'll assume that I've saved up $25,000 so that's the most I can spend. I'm looking to buy the same note as last week. To recap, that note has 244 monthly payments of $319.35 left, the loan's interest rate is 7%, and Bob (the borrower) currently owes $41,500. For the purposes of these calculations, I have to assume that Bob will continue to pay as normal until the debt is completely gone.
a) If I want to make 15% on my investment, how much will I buy the note for?
b) What if I want to make 20%?
c) 25%?
Let's say I bought the note for the amount in part c) (25% yield). If I collected payments for two years, Bob would still owe me $39,515.84 (we figured this out last week).
d) How much would I sell the note for after those two years if my buyer wanted to make 12% on their money?
e) How much would I make on my original investment if I did so?
THE SOLUTION:
a) N is 244, I/YR is 15 (that's the amount I want to make on my investment), PMT is $319.35, and FV is 0. Solving for PV, I find that I can pay no more than $24,314.98 for the note.
b) This calculation has the same setup except for I/YR, which is 20. Solving for PV, I find that my maximum purchase price is $18,821.50.
c) Same thing here, but I/YR is 25. My PV in this case is $15,228.68.
d) N is 220 (my original N of 244 minus 24, to account for the two years during which I've collected the payments), I/YR is 12 (the desired yield of my end buyer), PMT is $319.35, and FV is 0. When I solve for PV, I find that I'd offer the note for $28,357.62. The buyer who purchased it would get a 12% return on their money.
e) N is 24 (the amount of time I held onto the note), my PV is -$15,228.68(the answer to part c)), PMT is $319.65, and FV is $28,357.62(the answer to part d)). When I solve for I/YR, I find that my annualized return on my original investment is 50.84%. Pretty impressive!
DISCUSSION:
It makes sense I'd pay less for the note if I wanted a higher yield because paying less for the same thing means I'm getting a 'better deal'. A 'better deal' in this case is pretty much the same thing as a 'better yield'. This is true because I'm choosing different prices for the same note - different notes with different yields may or may not be better deals just because the yield is higher. Because different notes may have different property as collateral and different payment histories, one may be riskier than the next - which may be the reason for the large discount!
As you can see, if you can get good at buying notes and then re-selling them to investors who don't demand as high a return as you were able to buy them for, you can make quite a significant profit - both in terms of percentage and in real dollars.
Well, that's it for this week, I hope you enjoyed this article. Please feel free to hit me up with any comments or questions!
