The foremost reason why investors love real estate notes is that they provide surprise payoffs. You might have often heard about the various benefits of residual income - the payment that you keep aside while brokering, buying, or selling the notes. But it isn’t just something that’s said; it’s something that actually works.
Let us consider an example where you get lucky to receive a surprise payoff check of $57,569.28 for a note that you sold a decade ago. Well, isn’t it great? But before you get all too excited and think you can get rich overnight, let’s be clear that it will not happen on each deal that you will make. Moreover, an average fee for a note broker is about 3 to 6% of the total amount that is invested by note buyers. But combining the interest with time and partial purchases, you have an opportunity to earn some residual income.
You might think, how is it even possible? Well, here’s the example that will help you to understand it in a better way:
Suppose an investor has a deal from a seller with the following particulars:
Sale price is $135,000
The down payment is $10,000
The original balance was $125,000
Terms - 10% interest that is payable in 360 payments of $1,096 per month
The remaining term of 306 months
The remaining balance of $121,248.52
After negotiating for a bit, the investor decided to pay $95,000 for a purchase of all the remaining 306 monthly payments; hence, the investor purchased the entire payment stream of the note from the seller.
After that, for a purchase price of $97,500, the investor agreed to sell partials of just 186 monthly payment. He then realized that he made a quick profit of $2,500 by selling the note, yet he had the rights to receive the 120 monthly payment of $1,096 where each commenced in 15.5 years
So, here’s a quick recap of the example,
Payments bought by the investor: 306
Payments sold by the investor: 186
Payments retained by the investor: 120
The profit was made at closing, but even then, the investor had the right to a residual income stream in the future that was totaling over $130,000
In this way, the investor made a minimum fee of $2,500 and kept a piece of cash flow in the form of monthly payments for the future.
Schedule B Amortization & Partial Note Purchase
Well, if you are thinking, how is it possible, its high time you learn the time value of money and Schedule B amortization. This differs from the partial agreement, but generally, three amortization schedule at any point in time:
Schedule A - Total balance amortization that is owed by buyer or payer
Schedule B - Partial balance amortization that is owned by the investor
Schedule C - Remaining interest due to seller or note broker
In the example, when the deal was sold:
Full balance - A - $121,248.52
Partial balance - B - $103,515.87
Remainder balance - C - $17,732.65
Later, when the buyer paid off after a few years, the numbers changed:
Full balance payoff - A - of $96,915.46
Partial balance payoff - B - of $39,346.18
Remainder interest - C - increased to $57,569.28
Therefore, in the above example, the total and the partial balance went down when the monthly payments were coming in, but what went up was the remaining balance. And so is the power of interest because the rate of the note increased with time.