Why Is The Real Estate Note Buyer Offering Less Than What Is Owed?
by Julius Morrison,
published October 9, 2008
syndicated: 0 | total views: 78 |
word count: 779
laesbarhedsindex readability score: Easy Readability
website: http://www.intelnoteservices.com
W
hy is the contract buyer offering less than what is owed?
Contract buyers are legitimate business people. They want to buy your contract. They'll do everything they can to pay you top dollar. Of course, their business is governed by economic realities. Risk factors have to be carefully considered. When note buyers purchase a contract it's not like investing in a CD, or government bond. These instruments pay automatically without any hassles. Contracts, however, do carry some risk. Some of the risks the contract buyer must consider are:
1) The payment stream. Will it continue to come in on time? Does the person making payments have the ability to keep the payments current?
2) Will the house the contract is secured by be well maintained?
3) Will the market value of the house remain stable? Will the homebuyer pay their property taxes when they come due?
4) Will they always keep home damage insurance in force?
5) There's the possibility of default. No one has the ability to guarantee the future. Contracts that go into default are real hassles.
Foreclosure is expensive. A contract buyer would rather have a root canal than foreclose. Those are some of the risks that have to be considered. There has to be some profit potential built in to making it worthwhile for a contract buyer. That's one of the reasons why contract buyers offer less money than is actually owed.
The second reason for the discount is due to money's value over a period of time. This is an economic principal that needs to be clearly understood. A contract is a cash flow spread out over several years. It's not an appreciating asset. Each monthly payment is being paid with deflating dollars. What do we mean by deflating dollars? We all understand the realities of inflation. Inflation means a steady increase over time of the costs of goods and services. If the costs of goods and services are going up in the future, and a dollar is gradually losing its purchasing power, the contract buyer has a problem keeping the cash flow even with inflation. They say to themselves, 'What are these monthly payments going to be worth 5, 10, or 15 years from now'? By discounting the note, the contract buyer has a chance of keeping the cash flow even with inflation. How much discount is required depends on how long the contract is spread over time. A 10-year contract won't require the same discount as that of a 20-year contract. The faster the money is paid back the more its worth.
The time value of money is really easy to understand. Consider what inflation has done to the purchasing power of the dollar. How much less were the property taxes on your house 10 or 12 years ago? What did it cost for gasoline 10 years ago? If only we could buy a new car for the same price they sold for 12 years ago. What did auto insurance cost 10 years ago? Are you paying less for food than you were 10 years ago? How about entertainment and eating out compared to a few years ago? Medical costs have gone out of sight compared to a number of years ago. You see, the list can go on and on. The point is every day dollars are deflating. They will not buy in the future what they can buy today.
Let’s give you a visual example of the time value of money. Picture the two of us sitting at a table. I tell you that I want to give you some money. I put a five hundred dollar bill and a thousand dollar bill side-by-side on the table. You can either take the five hundred or the thousand. We would all take the thousand, right? But what if I told you there's a stipulation if you take the thousand. You have to wait ten years to receive it. Now, which bill do you want? The five hundred of course. Having cash right now in our hand is worth more than waiting. We would say to ourselves, 'how much will the thousand be worth ten years from now?' The contract buyer thinks the same way.
The current face value of a contract could be $60,0000.00. But what will those deflating dollars from the monthly payments be worth in the future? The contract buyer offsets those deflating dollars with a discount. That's what the time value of money is all about. O.K., you say to yourself,'I understand the reason for a discount. But it's still pretty hard to accept the discount when the contract is sold. Can I come out better'? Yes, absolutely. There are several ways to structure the sale to your advantage.
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