Posted by David Butler on August 15, 2005 at 22:17:30:
Hello Bob…
Actually, it might be alot easier for both of us if you started by explaining why you think these transactions wouldn’t be equivalent? That would go a long way in limiting the “possibles” of what it is you may be having difficulting in perceiving?
On a hunch, I’ll just say that some how you aren’t seeing that that all else being equal, the “collateral relationship” of the $100,000 note you only paid $60,000 for, is still the same. If you gave that seller a $100,000 note secured by the property you purchased, that property has no equity in it, and is fully encumbered by the seller carryback purchase mortgage.
If instead, you substitute collateral (the note you describe, or any other property the seller is willing to accept as collateral for the property being purchased); the property you purchase has 0 encumbrance, and a 100% equity it in to you. Equity you can borrow on, or trade yet somewhere else for $100,000 in equity toward some other type of property.
In the meantime, you are still only out the $60,000 you purchased for the $100k note you used as substituted collateral - to secure the note you gave the seller for the purchase of his property. To make it equivalent to a straight trade however, you would have to match the terms on the new note you gave the property seller to at least the equivalent terms of the note you purchased for $60,000.
Depending on total circumstances, you may even create better deal for yourself than a straight trade of the “discounted note”, for the property. What happens for example, if the $100,000 note balance you purchased is payable over 221 months remaining, at $927 p/m including 9% interest - and you use that note as “additional collateral” to persuade the $100k property owner to carryback 100% financing on the property you purchase, using no money down?
The new $100k purchase money note you give Mr. Seller is written at 180 month term, payable at $927 p/m including 7.5% interest; with the provision that the additional collateral (the $100k “discounted note”) only applies for say, the first five years of the new note’s life, and only collateralizes any shortfall between the resale price of property obtained by seller at foreclosure sale, and the balance remaining on the purchase money note.
So… your ownership of the $100k “discount note” gives you leverage to purchase a property with nothing down, and at favorable terms.
In the meantime, you keep the “discounted note” (or escrow it if Seller demands that) and earn a very nice “spread” between the 7.5% interest rate you are paying on “purchase money note” you gave the seller, in comparison to the 9% interest rate “discounted note” you paid $60k for (over and above the $40,000 discount premium you picked up on the purchase of the “discount note”).
During the 60 month “collateralized” period, you earn a total of $55,620 on the “discounted note” you own, and have a remaining balance still due to you of $86,650. (including $56,623 of your original $60k investment, which is earning a 17.84 yield).
You paid the same $55,620 on the “purchase money” note you gave the property seller. But, after 60 months, your balance owing on that note is only $78,097.
That spread will continue to grow during the life of both notes - and assuming for a moment that you simply use the payments from your “discounted note” to pay the payments on your “purchase money note” - at the time you pay off the property owner, you will still have a balance of $33,022 due to you on the discounted note, and 41 more payments coming in.
So… in addition to picking up $40,000 through the purchase of the “discount note” and using it to gain the financial leverage to obtain a $100k RE property with no money down - over the 180 month term of the “purchase money note” you gave to the property seller, you now own the property free and clear, and also gain another $33,000 in note payments! (plus any appreciation and income benefits you obtained from owning the property).
There are other ways to go as well… but not sure how can complain about this outcome either 
Hope that also helps add some perspective that helps you understand the equivalency you are looking for… and Many Happy Returns!
David P. Butler