Logic Behind Note And Structured Settlement Discounting

When the holders of real estate notes cash in their investments the resulting sales will almost always require some kind of discount. Here’s an easy explanation of the Investment to Value (ITV) method that many Note Buyers use to determine their pricing.

Most experienced Note Buyers have predetermined guidelines in mind that serve to narrow their focus to the notes that are likely to fit their buying preferences. Still, buyers will buy almost any note if the price is right – in other words, if the financial rewards are in line with the associated risk. To compensate for added exposure buyers adjust their pricing guidelines downward, which results in a higher yield.

Many buyers gauge their risk in a deal by considering their Investment to Value (ITV) percentage. ITV measures the amount of equity the Note Buyer has by comparing their purchase price to the property value. The amount of protective equity in the property is calculated by subtracting the ITV from 100. The lower the number or percentage the safer it is for the Note Buyer.

When a Note Buyer thinks that acquiring a note may be a risk, one potential resolution is to make a lower offer that decreases the ITV. A lowered ITV results in more protective equity for the Note Buyer.

An ITV-based buying example

Consider a house valued at $100K that secures a $95,000 note. If the Payor had poor credit or a history of missing payments this would be considered a risky situation. Since there is only $5,000 in equity any Note Buyer would want a mitigating factor to offset the risk involved in this purchase.

A smart way to improve this deal from the buyer’s perspective is to make a discounted offer. If a buyer offers only $60,000, the ITV would be 60 percent, giving the buyer a 40 percent of protective equity. That $40,000 of protective equity could help her to make a profit, even in a foreclosure situation. If the buyer incurs extra costs when foreclosing and reselling the house, the $40,000 of protective equity should more than cover the extra expenses.

Note Buyers always have to look after their own interests. Consequently, notes with small amounts of equity and a poor payment history are likely to see larger discounts in order to create protective equity for the buyer. This protective equity will help ensure that Note Buyers can recoup their funds if Payor default leads to foreclosure.

Also, depending on how much the Payor also has invested in the deal. For instance, if the purchase price of the home is $100,000, and the person only puts down $1,000, then the investor won’t feel that the payor has all that much invested in the property and the possibility of default is greater as opposed to the payor having invested a much greater amount. We call that “Teeth in the Deal”. How invested is the payor in the property.

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