I have been studying a Profit Strategy used by Banks and discovered the secondary mortgage note market. After discovering this market I liked this method of unlocking equity. I liked it even more when I realized this process can also be used by people who understand the underlying arbitrage and who understand how digitalization of physical assets creates further profitable arbitrage opportunities. So let’s analyze first the Mortgage, the it’s Face Value and then the Secondary Mortgage Market.
The Mortgage
You find a house you want to buy for 110,000 USD. You find a bank willing to loan you 100,000 on the home. You pay 10,000 USD and you borrow 100,000 USD to buy the house. The bank creates a promissory note, which states that you are borrowing 100,000 USD, at 10% interest and the loan term is 30 years. Additionally the promissory note.mThis note contains an amortization schedule which states how much the monthly payments are and how much of each payment is applied to the principle balance and how much is applied to interest owed on the loan. When this promissory note is for a home, apartment building or commercial building, it is called a mortgage.
Mortgage Face Value
What may shock you, is that on a 30 year loan, with compound interest you could end up paying the equivalent of between 50% and 100% of the original principle borrowed as interest. Which means if you borrow 100,000 USD, the total of your 360 payments over 30 years may equal 200,000 USD.. Now while that may seem shocking, it’s not a huge profit over thirty years. Maybe 3% return on investment per year. But that’s not what I want you to focus on here. What I want you to see is that the value of the mortgage is the sum of your payments or $200,000 USD. You borrowed 100,000, but you have agreed to pay back $200,000 USD and that number $200,000 is the Face Value of the mortgage. That’s the price that determines its value on the secondary market. So the Bank borrows money at a low rate like 2.5%, charges you a higher rate 10%, amortized the low at 10% compound interest over 30 years and the total cost of the loan to you will be $200,000. Now based on this inflated value of the loan/mortgage they can turn around and sell it in the secondary loan market for $120,000 at what is now perceived as a discount off its Face Value, so it sells quickly and the Bank gets their capital back, to loan out again and makes $20,000.
So now they can take that 120,000 USD and loan it to someone else to buy a house, and they get another mortgage which will have a Face Value of 240,000 USD and they can sell that mortgage in the secondary mortgage market and get 140,000 USD. Now they got their money back, plus 20,000. But the total profit from these two loans is 40,000 USD. NOTICE that the Bank isn’t waiting 30 years to get their capitol back. They get it back in a month or two. And each time they loan it out, they get paid very well.
Review
You find house for 110,000.
You put 10,000 down,
The Bank loans you 100,000.
You buy house and now the Bank holds a mortgage secured by your home.
You agree to pay 10%, compound interest, for 30 years.
The total amount you will pay back in 30 years is $200,000.
The Bank now has a Mortgage worth $200,000.
The Bank sells your $200,000 Mortgage for 120,000.
The Bank gets its 100,000 back, plus 20,000 profit.
The Bank can now loan out more money and repeat this process.
Profits from Private Placement Mortgages
Banks create a note or mortgage by creating a loan note/promissory note/mortgage. They inflate the total value of the mortgage with compound interest rates and long terms.sell these promissory notes or mortgages in a secondary market just for notes like this called a Commercial Paper exchange. You can do the same thing as a Private Money Lender to people who don’t want to use a bank. Private Placement Lenders are people or groups of people who lend money in a Person to Person arrangement. The loans are usually for higher interest rates and with a larger down payment then Bank Loans to protect the Private Money Lender. These same mortgages can have inflated Face Values and can be sold on the Secondary Loan Market, but at greater discounts due to the risky loans.
Bob find house for 100,000.
Bob puts 25,000 down,
You the Private Money Lender loans Bob 75,000.
Bob buys the house and now the You the Private Money Lender holds a mortgage secured by Bob’s home.
Bob agreed to pay 12.5%, compound interest, for 30 years.
The total amount Bob will pay back in 30 years is $150,000.
You now have a Mortgage worth $150,000.
You sell the $150,000 Mortgage for 90,000.
You get your 75,000 back, plus 15,000 profit.
You can now loan out more money and repeat this process.
Secondary Mortgage Markets are sometimes referred to as Commercial paper markets or exchanges. The world of Finance is truly amazing.
Stay thirsty for knowledge my friends!
Written by Shortsegments. ✍
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