Re: early payoff on note - Posted by Judy Miller - American Note
Posted by Judy Miller - American Note on January 25, 2000 at 11:25:51:
Computation of how to figure who gets what out of the early payoff on a note is one of the most difficult to explain. Here’s how I look at it:
First, there is the amortization of the actual note itself which secures the real estate. We call that “Schedule A”. This balance decreases every month as the mortgage is paid down. For example, if there are 360 payments originally, and now there are 20 paid, there are now 340 payments remaining. The remaining balance on Schedule A reflects the decrease in the principal balance. Let’s use the Original Note amount of $50,000, with an interest rate of 9%, amortized over 360 months (30 years), with monthly payments of $402.31. After 20 payments go by, the balance on the note is now $49,413.05. If the borrower were to pay the note off now and perhaps re-finance or sell the house to someone who got their own financing, the amount they would owe is $49,413.05. What we do is run an amortization Schedule A to show the remaining balance on the note at any point along the 360 payments.
Now comes the good part, “Schedule B”. If someone purchases a “partial” interest in a note at any point along the line, Schedule B starts running from that very starting point of the 1st payment that goes with that purchase. Let’s use an example. Someone purchases the next 180 payments of the note. Remember, 20 payments have already run on the 360 payment note, so we are purchasing payments #21-201 on Schedule A. But for Schedule B, we start out a brand new amortizations for the number of payments you have purchased, as if it is a note within a note, all based upon the face interest rate on the note. If you have purchased 180 payments, with the face interest rate on the note, 9%, (NOT YOUR INTENDED YIELD BASED UPON THE AMOUNT YOU PAID FOR THE PAYMENT STREAM),what you learn is that you have purchased an asset worth $39,665.24. This represents 180 payments @ 9%, @ $402.31, because that is what the borrowers are paying each month. Now this amortization schedule balance decreases each month as well, as the note is paid down. Let us assume that 25 payments of these 180 payments are paid down, and then the borrower refinances. Here is what happens:
There are now 155 payments remaining on Schedule B’s balance, or a present value or balance due of $36,794.71. That is what you are owed if you purchased 180 payments, 25 were paid down, and now the borrower is paying the original note off early for one reason or another. We are talking about the note in Schedule A that the borrower is paying off. You will receive $36,794.71 out of the payoff.
On Schedule A, what is the borrower paying off?
Remember, it was a 360 month note, 9%, $402.31 per month. The original note was for $50,000. When you purchased you partial interest the remaining balance on Schedule A was $49,413.05, after 20 payments had gone by. Now, since you purchased your 180 payment stream, another 25 payments have been made. The remaining balance on Schedule A at the time of our example where the borrower is now paying off the note, where there are a total of 45 payments paid down on the 360 month note, is now $48,544.58, with 315 payments remaining.
From this $48,544.58 which is all the borrower owes on Schedule A, you get paid off what you are owed on Schedule B, $36,794.71. The remainder is $11,749.87. This will go to whoever owns the residual interest, or the last 160 payments. It could be the same note holder/seller who sold the 180 payments, or it could be a note broker who purchased a full purchase and sold off a partial interest in the note, thereby keeping the “back-end”, or residual interest.
What is interesting is that the longer the borrower pays on the number of payments pre-sold, the more residual there will be for the back-end holder. However, the back-end holder has to wait longer to get the money. On the otherhand, with “time value of money”, maybe less now is worth more later.
In your example, where you kept the last 60 payments, what you will receive will depend upon whether the note is paid the whole time until your 60 payments start running, AND whether the purchaser in the first segment of payments has put some penalty provisions in the partial agreement, where they are entitled to some extra revenue in the event of early payoff. Even though their yield is higher if their Schedule B is paid off early, many do put in penalties for early payoff. Every purchaser of partials uses a different agreement, so their is no actual industry standard. But it is important to read the provisions, because that $11,749.87 could be decreased by a few thousand dollars in penalties.
Every time we purchase a partial interest, we give the parties a Schedule A and a Schedule B, with the explanation that B is deduced from A to indicated what the back-end holder will receive at any time along the payment schedules were the note to be paid off early.
Now this works as well with a foreclosure or default on the note. The Schedule B holder is actually in FIRST position, with the right to foreclose. To simplify, from the courthouse or other sale of the property, the Schedule B holder gets paid first, plus costs of foreclosure and collection, and whatever is left over goes to the Schedule A holder. The good news is that the Schedule B holder is limited to what they can receive, which is the balance on Schedule B, plus costs. The bad news is that Schedule B gets paid first and in full. On the other hand, if the property has grown in value, Schedule B does not share in the increased value of the property, and Schedule A can get the upside, if there is any. But at least Schedule A can get paid off. But unless there is a bidding war for a prized property, a property which would have probably not made it to foreclosure due to someone coming in to “save” the foreclosee, the most that is paid on these properties usually doesn’t cover enough to pay off Schedule A as well. This all gets into another entire discussion, for another day.