Private Mortgages: Interest -vs- Yield

What is the difference between interest and yield? Can the interest on a mortgage be changed without an agreement by both parties (Mortgage Lender and the Borrower)? Can the yield be changed without an agreement by both parties?
There are BIG differences between the two.

“INTEREST” is the interest rate stated on the Mortgage note. This interest rate CANNOT be changed without an agreement between both parties. Could there be an occasion wherein the parties would agree on the change in the interest rate stated in the note? YES.! There could be any number of reasons this could happen.

Here are a couple of examples.
There could be a balloon payment coming due which the borrower or payor is unable to pay. The Lender (note owner) might agree to extend the payment in exchange for an increase in the interest rate.
Subordination of this loan to a new loan. Say the mortgage is on a lot. The payor wants to build a home on the lot. The bank will agree to loan the money to build the house; however, the bank must be in senior or first loan position. Since there is already a loan on the property, the borrower asks the existing lender if he will subordinate (take second position behind the bank).
The existing lender might agree to this in exchange for an increase on the current face rate on the note. The bottom line is that usually the borrower wants something from the lender.
Sometimes the lender will agree to whatever the borrower wants by renegotiating the note – Most often with an increase in interest.

Could there ever be a time when the lender (note owner) would offer to decrease the interest rate on the note? The answer is YES! Why would the lender do this? The answer will be in the discussion of “Yield”, which comes up next.

Now let’s talk about YIELD – Yield is the anticipated return on a purchase of a mortgage note. “Yield” and ”Return on Investment” are synonymous.
Most private mortgages purchased by investors are purchased at a discount. For example –
Let’s assume that an investor is purchasing a mortgage note with the following numbers:
Balance Owed: $42,500.00
Note Interest Rate: 8%
Monthly Payment Amount: $406.15
Monthly Payments Remaining: 180

In this example, the investor desires a 12% Yield (Return) on his investment. We will use a financial calculator (in this case a Hewlett-Packard 12C – my favorite for many years).
By using the numbers given, we enter into the calculator the following numbers:
Number of Payments Remaining: 180
Monthly Payment Amount: $406.15
Now instead of the face rate of 8% – we enter the yield desired by the investor = 12% – Then we solve for present value = $33,841.09

Therefore, in this example the investor is purchasing the note at a discount of $8,658.91. The figures are very close to what investors are buying at today. The required yield, however, could vary greatly depending on what kind of property secures the loan, credit of the payor (borrower), payment history, etc.

In a future post, I will tell you how a person can become a Mortgage Investor without having to be wealthy in order to do it.

Now – About an example wherein the Mortgage Investor (Lender) would propose to decrease the interest rate for the borrower. Let’s use the same example as above. In this case the investor wants to increase his yield. A rule I learned from an instructor (Robert Ward) when I took my first CCIM Course many years ago is “More Sooner is Better” – Write that down in your things to remember.
OK – In our example the investor offers to decrease the interest rate from 8% to 4% if the borrower (payor) will increase the monthly payments to $812.30.
This might be very appealing to the borrower because now he would pay-off the loan in 58 months instead of 180 and thereby save $25,993.60.
What does that do for the investor? Let’s review the numbers:
Number of Payments: 58
Monthly Payment Amount: $812.30
The Investment Amount: $33,841.00
Using the HP-12C again, we calculate that now the investors yield is 14.35%. HOW ABOUT THAT PAPER MAGIC?

These posts are the opinion of the author who is not engaged in rendering legal, accounting, or investment advice. If such advice is required or desired, the services of competent professional persons should be sought.