I would like to show you an amazing way to make a greater return by getting paid less. That’s right, less. But what is really amazing about the scenario I am about to show you is that each party comes out a winner. That is why I called it a trick, because it seems magical.
In the wonderful world of notes, there are so many ways to make money. Unlike the poor saps at Bank of America who would lose money on this loan we are going to talk about, we can’t do anything but make money on it. But don’t shed too many tears for B of A, I think they are doing just fine.
This is one of the coolest ways to increase your return and make everyone involved happy in the end. It all revolves around the time value of money. We all know that a dollar in our pocket today is worth more than a dollar in the future. The sooner you get paid, the more valuable it is.
So, here’s the scenario: We buy a non-performing note at our usual discount of 85%. In other words, we pay $0.15 for every $1.00 owed of unpaid principal balance on the note. The numbers look something like this:
Terms for the Note, Once Re-Performing
$50,000 Unpaid Principal Balance
6% Interest Rate
215 Payments Remaining
$380 per Month
Our purchase price would be $7,500. Then let’s assume we have to spend $4,500 in costs to get the note re-performing again. We are now in it for $12,000 total.
The first thing we need to calculate is our current yield on this note now that it is re-performing. It turns out to be a very respectable 37.95%. We could stop right there and be very happy with that return, but why not juice it up a bit more?
After getting it re-performing, we call up the borrower, Barney, and ask him if there is any way he could double his payment each month. We know Barney’s financial situation because we own his loan. Essentially, we are the bank for Barney and we know he can afford more than what he is paying. So we offer Barney a deal. We tell him that if he can double his monthly payments, we can lower his interest rate by half to 3%.
That may not seem like much, but paying down principal and lowering the interest rate will really benefit Barney. He goes from paying …
215 Monthly Payments at $380 at 6% interest for a total of $81,700 over 17.9 years
72 Monthly Payments at $760 at 3% interest for a total of $54,720 over just 6 years.
That is a great deal for Barney. A savings of $26,980.
Great for Barney, but what about us as the owners of the note? It seems like a bad deal for us since Barney saved all that money and we are getting paid $26,980 less. However, due to the time value of money, we actually receive a better yield. Our yield now is a whopping 75% because we receive our money sooner rather than later.
That’s impressive. We could take it even further and increase our overall return and yield if we sold a portion of the note to another investor, but let’s leave that for another newsletter. Like I said, there are so many ways to make money in notes.
I know this trick is more mathematical than magical, but those who understand it can make magical things happen within their portfolio of investments. And the best part is, each party comes out a winner in the end because of the time value of money.