The financial community has been through some pretty tough times in recent years and many traditional lenders are finding any excuse NOT to make loans. Often times, they will try to write a paper A deal with paper B or C rates and if the principles accept it, they make the deal. The terms that the lender will offer are usually well below what they would have established historically. This means that the lender will offer, say, a 10% interest rate where it would have previously offered a 6% rate, or will offer to finance 70% of a purchase where it would have previously financed 90%. You’ve probably heard this on the news where good solid buyers can’t get bank loans for their businesses or to buy houses or cars or whatever. Financial markets are tense. However, people still need cash to buy houses, cars, and items for their businesses, so they have turned to the private market to meet their financial needs. Even in the best of cases, 90% of all financing for the sale of small businesses has been seller financing.
Once these notes or paper have been created, the beneficiary (generally the seller) receives monthly payments that include principal and interest on the amount they financed for the buyer or payer. Since these note holders are individuals and not financial institutions, there is a limit to the amount of capital that they can have immobilized in these financial instruments. They often need to release this cash and sell the tickets so they can make other deals or buy other equipment, cars or houses, etc. They need a buyer to pay them the cash balance of the amounts still owed to them or as close to this balance as possible. Typically, these buyers of this paper demand a return on their investment that is higher than that required by institutional finance companies.
As an example, if the prevailing FNMA mortgage rate on a first mortgage is a fixed 5% for 30 years, a private investor could demand and obtain a 10% return on their invested capital. Since once the note is created and the terms of the note are established (interest rate, term, etc.), it cannot be changed. The way in which the investor in notes obtains his return of 10% on a paper to 5% is by means of the discount. This means that the buyer of the ticket will only pay, say, $ 80,000 for the remaining balance of $ 100,000. This is a difference of $ 20,000 or 20%. This difference is the discount. There is nothing magical about this 20% and it fluctuates up and down depending on many variables in the transaction, such as: collateral type, nominal interest rate, remaining term, owner-occupied or not, payment history, loan profile. buyer / payer, etc. It is safer and better to have the underwriting of all these variables or due diligence, as it is called, performed by a professional firm.
Thanks for your time,
TJ Stewart, Founder and CEO