A note discount is the difference between the balance your payer still owes and the price a buyer pays you for the note. If $129,400 is owed and the buyer pays $115,000, the discount is $14,400.
Illustrative example. The figures on your own note will differ.
How it is stated
Balance owed, minus price paid, equals the discount. You will see it in dollars, $14,400 in the example, and as a share of the balance: $14,400 divided by $129,400 is 11.1%. The same offer can also be described from the other side, as a price of about 89 cents on the dollar.
Where the discount comes from
A buyer begins with a yield, the yearly return they need on the money they pay you. The discount is whatever is left over once the price has been set to deliver that yield, so nobody chooses it directly. That mechanism is why notes sell for less than the balance at all.
The example note carries a 6% interest rate and the buyer needs 8%. Payments that were set up to pay 6% can only return 8% to someone who pays less than the balance for them. At $115,000, the 168 remaining payments of $1,140 do that, and the $14,400 follows.
Its size depends on the gap between your note’s rate and the buyer’s yield, and on how long the buyer has to wait. A wider gap means a bigger discount, and the same gap applied over more years means a bigger one still. The yield itself rises with risk, so late payments, thin equity in the property or a second lien, each a part of what your note is worth to a buyer, all push the discount up.
Discount, fees and the buyer’s return
The discount is the price of receiving 14 years of payments today. Fees are a separate matter. Title work and a broker’s pay are charges for services, and a clear offer lists them apart from the discount. On our offers, what we earn has its own line on the worksheet.
The buyer does not pocket the discount at closing either. Their return arrives one payment at a time, and only if the payer keeps paying. A buyer whose payer defaults can lose money on a note bought below its balance.
One more figure belongs next to the discount when you weigh a sale. Kept to the end, the example note pays $191,520 in total. Sold, it pays $115,000. The discount measures the cost against the balance, while that larger difference is the interest you give up in exchange for having the money now and the risk off your hands.
Is a bigger discount always a worse deal?
A discount tells you how far the price is from the balance, and says nothing about whether the price is fair for the note. A long note at a low rate will carry a large discount even from a buyer asking a modest yield. A short note at a high rate will carry a small one and can sometimes sell near the balance.
To judge an offer, ask what yield it gives the buyer, then compare that yield with other offers on the same note. What a fair discount looks like shows how to tell.
How to keep the discount down
- Get more than one offer. Buyers need different yields, so they arrive at different discounts on the same note.
- Sell fewer payments. In a partial purchase you sell a set number of payments and the rest of the note returns to you. Buyers discount the farthest payments hardest, so keeping those shrinks what you give up. In the example, the next 60 payments sell for $56,200. See whether the discount is lower on a partial.
- Remove doubts. Proof of on-time payments and complete documents give a buyer less reason to raise their yield.
Some discount remains for as long as your rate sits below the yield buyers need. If the discount on offer is more than the cash is worth to you, keeping the note is a sound choice.
Checking the discount on an offer
When an offer arrives, find the balance the buyer used, the price and the yield. Subtract the price from the balance for the discount in dollars, and divide that by the balance for the percentage. Then compare the buyer’s balance with your own records, because an offer priced on the wrong balance shows the wrong discount.
Offers that come through our note pricing request state those figures on a worksheet, so the subtraction is already done and the balance is there for you to check against your own.
Related questions
Is the discount the same as the buyer's yield?
No. Yield is the yearly return the buyer earns. The discount is the dollar gap between the balance and the price. A buyer chooses the yield, and the discount is the result.
Do I pay the discount out of pocket?
No. Nothing is paid by you. The discount is simply the amount by which the price falls short of the balance owed on the note.
Does a note ever sell with no discount?
It can happen when the note's interest rate is at or above the yield a buyer needs and the risk is low. When the rate on the note is below what buyers need, some discount follows.