I am often asked which is the best approach to analyze a note for the amount of the discount; collateral or yield? While both are important, this is a good time to discuss three factors when purchasing a note.

1. LTV (Loan to Value)
2. ITV (Investment to Value)
3. Yield.

LTV can be defined as the ratio of the loan to the value of the property. For example, a $100,000 property that sells with 5% down and a $95,000 loan has an LTV of 95%. The higher the LTV, the higher the risk of the loan. Why? Because a high LTV at the initiation of a mortgage indicates how much "skin in the game" the borrower has put at risk.

To put it in perspective, if a borrower puts only 5% down on a mortgage, who is actually taking the bigger risk; the borrower who has only $5,000 at risk, or the lender who has $95,000 at risk, with collateral of $100,000? Doesn't the lender have more at risk than the borrower?

Contrast 5% down, to a borrower who puts $20,000 or 20% down on a $100,000 house, with an $80,000 loan. The LTV is now 80%, as well as the borrower has $20,000 invested in the property. Not only does the borrower have "skin in the game", but should the borrower get into trouble, the borrower will have more of an opportunity to sell the property to get some, if not all of his/her investment back. Add to this that the lender's collateral is higher with an 80% LTV, than a 95% LTV.

Let's take this scenario into the future ten years where the note has been paid down to $83,000. What is the LTV? 83%, right? Now who has the most at risk, the borrower or lender? Since the borrower now has $17,000 equity, as opposed to the original $5,000, the probability the borrower will just walk away is reduced.

More importantly, since there is ten year's of seasoning, the borrower has what is called "emotional equity"; meaning the borrower has established roots in the community, schools and employment. In other words, even though the borrower put only 5% down, as time went on, the borrower accumulated equity, as well as demonstrating to a Note Buyer the borrower is a safer risk than ten years earlier when the borrower had virtually no risk because of the small down payment.

For a Note Buyer, the LTV indicates the amount of "skin in the game" that a borrower put at risk at the origination. As time moves on, the LTV reflects the monetary equity a borrower has accumulated, as well as emotional equity the borrower has attached to the property.

With this in mind, let's examine ITV or investment to value. ITV can be defined as the amount a Note Buyer has invested in the note divided by the "as is" value of the property. To minimize the Note Buyer's risk, ITV should be tied to the credit score, down payment and property value. Remember, the only real protection a Note Buyer enjoys is the collateral, or value of the property in the event of default.

Since we know the collateral can be devalued by market conditions and/or deterioration of the property, ITV is very important to the amount of the discount a Note Buyer requires.

In the above case study, let's assume the house sold for $100,000 with 5% down, and a $95,000 mortgage at 8% for 30 years, with payments of $697.08. Let's further assume the borrower's credit scores are in the low 600s, and that because of the low credit scores and low down payments, a Note Buyer requires a 65% ITV and at least a 11% yield. What would the Note Buyer offer to receive an ITV of 65% and AT LEAST a 11% yield.

For a 65% ITV the Note Buyer would pay $65,000 (65% of $100,000)
To receive an 11% yield a Note Buyer would pay $73,197 (Calculation of PV to receive 11%)

Since the offers are quite different, which one will the Note Buyer favor? The Note Buyer will favor the $65,000 offer. Rule of thumb: A Note Buyer will offer the acceptable ITV or yield, WHICH EVER IS LOWER. (For those who are following on their calculators, how does the $65,000 offer affect the Note Buyer's yield? Did you get 12.57%?)

In conclusion: LTV tells a Note Buyer how much "skin in the game" the borrower has, or how much monetary or emotional equity the borrower has in the property. ITV, on the other hand, tells the Note Buyer how much he/she will invest in the note in relation to the value of the property.

At the same time, yield is determined by the Note Buyer by the best use of his/or her money.

The amount the borrower has invested, along with the value of the collateral and borrower's credit score will determine the ITV for the Note Buyer. Yield is the rate of return a Note Buyer demands.

When applying LTV, ITV and Yield to the purchasing of a note, all three are important and should be tied to one another.

In other words, the down payment, credit score, value of the property and equity in property should be tied to the ITV and yield a Note Buyer demands for the purchase of a note. The more risk a Note Buyer incurs because of high LTV the lower the ITV, and conversely, the higher the yield. The Note Buyer will offer the lesser of the ITV vs yield. Remember: YIELD IS NOT REALIZED UNTIL PAID OFF. ITV is an excellent method of minimizing risk to the Note Buyer.

Next month we will examine how partials are an excellent method of applying ITV and yield to minimize the risk of the Note Buyer, as well as providing the note seller with a lump sum of cash, with a minimum discount.

If you have questions or comments, be sure to CONTACT ME I get the topics for my newsletters from your input.

Copyright © H&P Capital Investments LLC
All rights reserved
Tom Henderson
a.k.a. THE NOTE PROFESSOR

If you have not attended a Note Professor "How To Get Rich with Notes" class, be sure and purchase the Note Professor Note Book manual to enhance your knowledge of creative real estate financing and note buying and selling.

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By popular demand, THE NOTE PROFESSOR NOTEBOOK is now available in easy, downloadable E- book form for a the low, affordable price of $39.95.

Other products are also available, including HOW TO MAKE OBSCENE PROFITS with SMALL MONEY, and GUIDE FOR SECOND LIENS. There is also a FREE download of CHECK LIST FOR OWNER FINANCING.

Simply go to the NOTE BUYERS STORE. I can think of nowhere that you can find such information packed products at such incredibly low prices. We are still working out the bugs, so if you have any problems, be sure to contact me.

I have several projects to finish this week, so I did not have time to devote to writing an economic column. However, I will convey some thoughts that economist and philosophers, both present and past, have conveyed about free markets. Notice the issues they were fighting for are as valid today as in the past. Their cumulative wisdom will represent free markets better than any article I write.



When you see that trading is done, not by consent, but by compulsion -- when you see that in order to produce, you need to obtain permission from men who produce nothing -- when you see money flowing to those who deal, not in goods, but in favors -- when you see that men get richer by graft and pull than by work, and your laws don't protect you against them, but protect them against you -- when you see corruption being rewarded and honesty becoming a self-sacrifice -- you may know that your society is doomed.
Ayn Rand

When buying and selling are controlled by legislation, the first things to be bought and sold are legislators.
P.J. O'Rourke

Everyone wants to live at the expense of the State. They forget that the State lives at the expense of everyone.
Frederic Bastiat

Whatever crushes individuality is despotism, no matter what name it is called. 
John S. Mill

Emergencies have always been the pretext on which the safeguards of individual liberty have been eroded.
F.A. Hayek

Freedom in economic arrangements is itself a component of freedom broadly understood, so economic freedom is an end in itself. Economic freedom is also an indispensable means toward the achievement of political freedom.
Milton Friedman

The 'private sector' of the economy is, in fact, the voluntary sector; and the 'public sector' is, in fact, the coercive sector. Henry Hazlitt

The direction of all economic affairs is in the market society a task of the entrepreneurs. Theirs is the control of production. They are at the helm and steer the ship. A superficial observer would believe that they are supreme. But they are not. They are bound to obey unconditionally the captain's orders. The captain is the consumer. Consumers make poor people rich and rich people poor. They determine precisely what should be produced, in what quality, and in what quantities.
Ludwig von Mises

Every election is a sort of advance auction sale of stolen goods.
H.L. Mencken

The free market punishes irresponsibility. Government rewards it.
Harry Browne

A government which robs Peter to pay Paul, can always count on the support of Paul.
George Bernard Shaw

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.
Henry Hazlitt

No man's life, liberty or property are safe while the legislature is in session. 
~Author Unknown

A claim for equality of material position can be met only by a government with totalitarian powers
F.A. Hayek

Now, legal plunder can be committed in an infinite number of ways. Thus we have infinite subsidies, encouragements, progressive taxation, public schools, guaranteed jobs, guaranteed profits, minimum wages, a right to relief, a right to the tools of labor, free credit, and so on, and so on. All these plans as a whole-with their common aim of legal plunder-constitute socialism.
Frederic Bastiat

But how is this legal plunder to be identified? Quite simply. See if the law takes from some persons what belongs to them, and gives it to other persons to whom it does not belong. See if the law benefits one citizen at the expense of another by doing what the citizen himself cannot do without committing a crime.
Frederic Bastiat

What kind of society isn't structured on greed? The problem of social organization is how to set up an arrangement under which greed will do the least harm; capitalism is that kind of a system.
Milton Friedman

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. Nobody but a beggar chooses to depend chiefly upon the benevolence of his fellow citizens.
Adam Smith

Whoever claims the right to redistribute the wealth produced by others is claiming the right to treat human beings as chattel.
Ayn Rand

Every man has a property in his own person.  This nobody has a right to, but himself. 
John Locke

Were we directed from Washington when to sow and when to reap, we should soon want bread.
Thomas Jefferson

The essential characteristic of socialism is the denial of individual property rights.
Ayn Rand

A wise and frugal government, which shall leave men free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned - this is the sum of good government.
Thomas Jefferson

One function of profits, in brief, is to guide and channel the factors of production so as to apportion the relative output of thousands of different commodities in accordance with demand. No bureaucrat, no matter how brilliant, can solve this problem arbitrarily. Free prices and free profits will maximize production and relieve shortages quicker than any other system. Arbitrarily fixed prices and arbitrarily limited profits can only prolong shortages and reduce production and employment.
Henry Hazlitt

Liberty is an opportunity for doing good, but this is only so when it is also an opportunity for doing wrong.
F.A. Hayek

A claim for equality of material position can be met only by a government with totalitarian powers.
F.A. Hayek

There is no more certain way to deter employment than to harass and penalize employers.
Henry Hazlitt

No man will labor for himself who can make another labor for him.
Thomas Jefferson

There is all the difference in the world between treating people equally and attempting to make them equal.
F.A. Hayek

Government cannot make man richer, but it can make him poorer.
Ludwig von Mises

The desire for an increase of wealth can be satisfied through exchange, which is the only method possible in a capitalist economy, or by violence and petition as in a militarist society, where the strong acquire by force, the weak by petitioning.
Ludwig von Mises

The politician attempts to remedy the evil by increasing the very thing that caused the evil in the first place: legal plunder.
Frederic Bastiat

Underlying most arguments against the free market is a lack of belief in freedom itself.
Milton Friedman

Practically all government attempts to redistribute wealth and income tend to smother productive incentives and lead toward general impoverishment. It is the proper sphere of government to create and enforce a framework of law that prohibits force and fraud. But it must refrain from specific economic interventions. Government's main economic function is to encourage and preserve a free market. When Alexander the Great visited the philosopher Diogenes and asked whether he could do anything for him, Diogenes is said to have replied: "Yes, stand a little less between me and the sun." It is what every citizen is entitled to ask of his government.
Henry Hazlitt

All people, however fanatical they may be in their zeal to disparage and to fight capitalism, implicitly pay homage to it by passionately clamoring for the products it turns out.
Ludwig von Mises

We must face the fact that the preservation of individual freedom is incompatible with a full satisfaction of our views of distributive justice.
F.A. Hayek

"Freedom is] the societal condition that exists when every individual has 100% control of his own property."
Andrew Galambos

CONSUMPTION CANNOT EXCEED PRODUCTION.
Tom Henderson

Just food for thought.

If you have a comment or a topic you would like discussed, CONTACT ME It is from your input I get many of my topics.

Copyright © H&P Capital Investments LLC
All rights reserved
Tom Henderson
a.k.a. THE NOTE PROFESSOR

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