Understanding Note Discounts
When selling a real estate note, the seller generally receives less than the remaining balance, known as a discount. This discount compensates the note buyer for risks like potential borrower default, unexpected property issues, and market fluctuations that could affect property value.
Key Factors That Influence Discounts:
- Borrower Credit: Higher credit scores signal less risk and often result in a smaller discount.
- Down Payment: Larger down payments create more equity, reducing risk and increasing the note’s value.
- Payment History: A consistent payment history makes a note more valuable and reduces the discount.
- Interest Rate: Higher interest rates provide better returns for note buyers, which can reduce the discount.
Example Scenarios:
- Scenario 1: Property value: $150,000, Down payment: $50,000, Borrower credit: 700, Offer: $85,824 (around 86% of balance)
- Scenario 2: Property value: $105,000, Down payment: $5,000, Borrower credit: 600, Offer: $76,036 (around 78% of balance)
Discounting a note depends on factors that impact the perceived risk, with strong notes commanding higher purchase percentages.