April 21, 2008
The Provocative Partial
*Due to the interest generated by this topic, we are leaving it up for an additional week.*
Prior to my junior year in college, the summer of 1990 was spent waiting tables in the Ptarmigan Dining Room at the Many Glacier Hotel in Glacier National Park. On a particularly busy evening, we began to run out of several menu items, with no re-supply scheduled until the following day. By the end of the shift, I was forced to tell two tables of diners that they could order anything on the menu as long as it was the trout. I often look back to that night when I think about how I want to be treated by the companies I do business with. In other words, can they provide me options or is it a “one size fits all” proposition?
As consumers, we want options – they allow us to make the most informed decision based on our wants and needs. This is the reason I like to offer partial purchase options to noteholders who call me with a note to sell. A partial purchase allows a noteholder to sell a portion of their payments to us, and lets them keep the “back-end” payments, starting at a future date.
The partial purchase is a win-win for the buyer/investor and the seller. The note buyer minimizes its risk in the note by limiting its exposure in the property. The seller gets a lump-sum cash payment now, and when the payments revert back at a future date, the balance on the note will still be quite substantial in most instances.
I have provided an example below on an actual note that was submitted to me recently:
A single-family residence sold 1/2/08 for $174,000. The borrower gave $5,000 as a down payment and the seller took back a note for $169,000 at 6% interest (payment $1,013.24) over a period of 30 years. The borrower had a credit score of 608 and the note had been seasoned three months, making the current balance $168,492.75, and the LTV (loan-to-value) on the note almost 97%.
With that level of exposure, minimal seasoning, and mostly poor credit, many note buyers/investors are going to steeply discount the full purchase to make themselves comfortable with their ITV (investment-to-value). They may not even offer a full purchase for those very reasons. In this scenario, I proposed buying the next ten years of payments (120 payments), leaving the remaining 237 payments to revert back to the seller in early 2018. The net present value of those 120 payments is $91,266.03. This is the amount the note buyers/investors are entitled to receive. In other words, this is the investor’s balance that the payments are applied against.
Once the buyer/investor receives the entitlement in full, the remaining payments are then reassigned back to the seller. Using the example above and assuming all payments are made as scheduled, the seller will once again begin receiving the payments starting in early 2018. At that time, the outstanding principal balance will still be $140,506.05! This is because the majority of the buyer/investor’s entitlement was interest over the first 10 years. As time progresses, more and more of each payment goes to pay down the principal balance owing on the note.
In the event of an early payoff by the borrower, the amount the seller receives will not be the $140,506 referenced above. This is because the buyer/investor is still entitled to their portion of the payments. However, the upside to this scenario is that the seller receives another lump-sum payment earlier than anticipated, and can therefore put that money to work for them immediately in another investment. If invested smartly, that money will have grown into a sum much larger than what the seller would have received if the note had continued to be paid out over time.
Partial purchase options are beneficial to all involved, and can be an effective and attractive alternative to selling your entire note. Consider ALL your options when selling your note – remember, you don’t have to settle for the trout if you’d rather have steak!
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broker, or anyone other than the actual note holder, please do not contact