Since the majority of secondary market notes are sold at a discount, you have to do a little work to determine your actual annual yield. You will generally do better than the stated interest rate. Let’s take an example note.
Property Address: 123 Fake Street Randomtown, USA
Borrower Owes: $100,000
Interest rate: 4.28%
Monthly Payments Remaining: 200
Monthly Payment Amount (Principle & Interest Only): $700
If you were to buy this note at full price your annual yield would be the same as the interest rate (4.28%). I like to use a financial calculator to verify this. There’s an android app I use called 10bii Financial Calculator ($5, also available on other platforms). There I can enter any 3 of the first 4 values on the top row (N = number of payments remaining, I/YR = Your Yield, PV = Your investment/purchase price, PMT = The monthly principle and interest payment). I can enter N=200, PMT = 700, PV = -100000, and then click on I/YR without typing anything else and it will calculate the yield of 4.28.
4.28 might be fine for a bank on a very reliable loan, but we want a better return.
Let’s see how much of a discount we would need to get a 14% return.
Change I/YR value to 14, then click on PV. This will calculate a PV value of -54102. If I can buy this note for $54102 and receive a monthly payment of $700 for 200 payments, my average yield will be 14%.
This gets us in the right ballpark, but there are 2 other factors to consider that can lower your yield. Most servicers will charge a monthly servicing fee of $15 per note, so we don’t really receive $700 every month. We receive $685.
Change the value in PMT to 685, then again click on PV. This changes the calculated purchase price to -52943. If I want my full 14% yield, I would have to buy the note for $52943.
The last factor is any transaction fees charged to acquire the note. This could be fees charged by the note exchange themselves (FCI charges 1% or $500, whichever is more), fees to have the assignment and along recorded with the county (FCI charges a flat $200), or bank wire fees. If I anticipate $800 of fees, and still want my 14% yield, I’ll have to lower my offer by that $800. For the note above my final offer would likely be somewhere around $52100.
Even if the list price is up to $60K for this particular make belie
ve note, I would still submit my offer. The seller may say no, or try to negotiate, but you won’t know if you submit an offer. Depending on how long they have been trying to sell the note, they may just be anxious to get it out of their hands.