Example 5: Three ‘Staged Funding' of $7,000 for the first 6 years of a note.

This is a deal done by a friend of one of our coaches. He was a very experienced note buyer. His personal portfolio of notes usually had about 300 notes.

A young man approached him and asked how much he could pay for his $37,000, 10-year, 2% note (Yes, that’s right – only 2%). The payments were about $325 per month. The Investor offered him about $18,000 for the note. This was a pretty steep discount, but it was an unseasoned note and too low of an interest rate. An interest rate this low is not likely to pay off early and that is where investors make a significant increase in the yield on a note. Further, there was a very low down payment and so practically no equity to maintain any level of safety in the note. The young man told him that he would get back to him after he thought about it.

The young man called him back about a month later and said that he had decided to not sell the note. The investor, being a very experienced investor, first congratulated him on the decision. Then, told him that it was a good note and that the wise thing to do was to hold on to it for the long term (notice that he FIRST agreed with the note holder). He said, since he was a very experienced investor, that if things ever changed to where the young man needed money that he could always call on the investor at that time and get a new quote on the note (he “planted a seed” for the future).

Finally, being a very experienced investor, he inquired about what the young man intended to do with those little monthly payments (he begins to probe for information). The young man replied that his parents had died in a car accident several months earlier and that he had inherited their home. He had decided to do something that they had both encouraged him to do for many years.

He was going to quit his job at the end of the summer and go to law school. He had a position lined up where he would manage an apartment complex and get a place to stay and a very small salary. The law school was going to set up a payment plan for him and he would need the payments from the loan to make those payments.

My client congratulated him on that decision. He then said that he could see that the young man would be on a very tight budget and wondered where he found a law school with tuition of only $3,900 per year ($325 X 12). The young man told the investor that it would actually cost about $7,000 per year, but that the school had set up a student loan of $3,000 per year. He would not have to pay on those loans until 6 months after he graduated.

The Investor then congratulated him on the way that he had planned this out and the asked him how comfortable he felt about the person that had bought the house. He asked him what would happen if that person was late on a payment or actually defaulted altogether.

The young man said that he was a little bit uneasy about that. He mentioned that if that payment didn’t come in on time, he would be really hurting because he wouldn’t have a real job for the next three years. He didn’t think that any bank would give him a loan under those conditions.

Now the investor, being a very experienced investor, had some information that he could work with. He told the young man that there might be a better, safer way to handle these finances. He suggested that the young man meet with him in a couple of days and go over a different proposal.

A couple of days later, they met together and he presented the young man with the following offer. The investor would pay the young man $7,000 at the beginning of the coming school year. In return, the investor would get the next two years of the monthly payments. Then, when the second year of law school began, the investor would give the young man another $7,000 in return for the 3^rd and 4^th year’s payments on the loan. Finally, the investor would pay another $7,000 in return for the 5^th and 6^th year’s payments on the loan.

The young man then said, “Let’s see, each time you give me $7,000 you’ll receive 2 years of payments or about $7,800. So, you’re getting $800 more than you’re giving me. That’s about $400 in interest per year or about 5%. I think that sounds pretty good.”

The investor then said, “That’s not all that you get though. Keep in mind that when you graduate you will not owe those three $3000 loans that you were going to be getting.” The young man was really excited about that.

“And,” he added, “You will also get the note back in 6 years. That will be another four years of payments that you’ll receive.”

“Wait a minute,” the young man said, “how does that work?” You said you would pay me $7,000 three times. That’s $21,000. Now you’re telling me that I will get about $4,000 more for each of the last four years. That’s another $16,000. I will be getting $21,000 plus $16,000, or a total of $37,000 for this note. You told me initially that you would pay only $18,000 for the entire note. You must have made a mistake, right?”

The investor just answered, “It works for me if it works for you.” They young man accepted the offer. The annual yield to him comes out to be about 18.59%.

Look at that $21,000. Did the investor really give up $21,000? Now, be thinking with the “Time Value of Money” part of your brain.

No. Maybe he got $21,000 from his perspective, but the investor did not give $21,000. First, he gave the young man $7,000. By the time that he gave the second $7,000 it was more than one year later. What do you suppose was happening to this $14,000 that was not yet in the possession of the new law student? Well, it certainly was not under the investor’s mattress - or even in his savings account. In fact, the investor had made more than $1000 on that money before he gave out the second $7,000 and more than $2,000 on the final pay out of $7,000 before it was paid.

So, that $21,000 only cost the investor less than $18,000. To the law student, using simple cash on cash figuring, he was giving up a total of about $23,400 in return for $21,000 - or, $2,400 in interest over 6 years. To him, that was about $400 per year interest in return for $21,000.

But, that was not the end of this deal. Guess what happened 6 years later when the young man was due to get the note back. The investor called up the note seller to inform him that he would begin receiving those payments starting the next month.

The young man had now graduated from law school and had been in his new job for three years. He said that the timing was just perfect. He said that he could really use those payments now. The investor, being very experienced, asked the young man what he intended to do with those payments. He then found out that the young man had recently gotten married and they were looking at homes to buy. The home that they both really wanted was just a bit more expensive then they felt comfortable with. The payments were just a bit too steep. But, now with these payments, he would feel a lot more comfortable with taking on that obligation.

The investor, being very experienced, congratulated him on the decision to buy that home. Then he asked him what he would do after four years when the note would be paid up. The young man said that maybe he would have a pay raise by then to help make up the difference.

The investor then suggested that there might be a better way to handle these bigger payments. “In fact”, he said, “I can show you how to have lower payments for as long as you live in the house, not for just the next four years”. He then showed him how he could sell the last 4 years of that loan for a lump sum of $13,000. “Then,” he said, “you can dramatically increase the amount of your down payment. This will make those monthly payments lower for as long as you live there – not just for the next 4 years.” The young man said, “Great, how soon can I get that money?”

What you want to be aware of in this last offer is, first, the investor was prepared in advance of the call to make this offer. He just didn’t yet know what the need would be for the offer and he held off making the offer until he found the need.

Second, having found out the need, he did take a moment to figure out exactly how much the payments would be decreased after the additional $13,000 was put down. But, he did not present those figures to the note holder, although he would have if the subject had come up. He kept it as simple as possible.

Third, he had alternate offers to make – just in case. He was ready to offer more for the note if it was necessary.

Fourth, he could have offered more because it was now well seasoned. Also, since the economy had changed and interest rates were somewhat lower, he could look at it with a lower yield and still be comfortable with his purchase.

Who got the best part of this deal?

The investor got a consistent 18.59% on this note. This was a good deal for him in the beginning because he was into it for only $7,000 at a time. If the note had proved to be a poor paying note, he just wouldn’t have bought the additional partials. The young man got a law degree, with no worries about having to collect payments. He also did not have any student loans to pay back. He also got a home with lower payments for as long as he lives there. You be the judge.