Why a Discount?:
It is the most frequently asked question: Why is there a discount when I sell my
mortgage, annuity or lottery winning? The answer is that the discount is
necessary so that the investment company buying the mortgage, annuity, etc. is
able to pay its overhead, make a profit and stay in business!
What does that mean? Here is an example: Assume that you are receiving payments
from a $500,000 mortgage that is paying you 7% interest. On the surface, 7% is a
pretty good rate of interest. However, the investment company buying that
mortgage typically borrows its money at 6 – 10%. The investment company has to
pay its overhead (i.e. office, staff, advertising, etc.). The investment company
has to have enough cash reserves so that if the mortgage stops paying, the
company still has enough money to pay all of the above expenses while the
foreclosure is completed and the property is re-sold. Finally, the company needs
to make a profit to stay in business and make all of the above worthwhile.
What is an average discount? Depending upon the exact terms of the mortgage and
the financial strength of your borrower, the discount on a quality first
mortgage can be 5-25%. That discount translates into a buy price of $375,000 -
$475,000 for that $500,000 mortgage. If you sell only part of your mortgage, the
discount would be less.
If you are receiving payments from an annuity or lottery, some of these do not
earn any interest at all. A $1,000,000 lottery that pays out $50,000 per year
for 20 years pays no interest at all. Consequently, it is not uncommon for the
discount in these instances to be over 50%. In fact, where some states offer the
winner the choice to take a lump sum versus the annual payments, the lump sum is
usually less than half of the quoted winning amount.
Simply put, it is the discount that provides the marketplace for the owners of
these mortgages, annuities and lotteries. The discount enables these owners to
sell these assets that otherwise would not be saleable.