What is a Discounted Mortgage?
First of all, what is a Mortgage?
A discounted mortgage means you can buy the existing mortgage at a discount, that is to say, for less than the principal balance owing. Thus you might be able to buy a mortgage with a current principal balance of $40,000 for $35,000.
If you can find an investor who is willing to pay you $37,000 for this mortgage, the $2,000 difference is your profit.
An existing mortgage is a mortgage that someone else is already receiving payments on. Nothing changes for the borrower if you buy this mortgage. They simply send their payment to you instead of the original lender.
Why discount a Mortgage?
You may not be aware that almost every mortgage in the United States has been sold, and usually for 100% of face value.
How can this be?
Quite simply if you buy a home and get a mortgage from your local bank, they do not usually keep that mortgage as an investment. Although they often keep the servicing rights for a collection fee.
Instead they sell that mortgage to a Secondary Mortgage buyer, often Fannie Mae or Freddie Mac.
Fannie Mae and Freddie Mac are government supported private companies on the new York Stock Exchange.
Fannie Mae
Fannie Mae stock (FNM) is part of the Standard & Poor’s 500 Composite Stock Price Index.
In 1938, the Federal government established Fannie Mae to expand the flow of mortgage money by creating a secondary market. Fannie Mae was authorized to buy Federal Housing Administration (FHA)-insured mortgages, thereby replenishing the supply of lendable money.
In 1968, Fannie Mae became a private company operating with private capital on a self-sustaining basis. Its role was expanded to buy mortgages from other lenders such as Banks and Savings and Loans.
Freddie Mac
Freddie Mac is a participant in the secondary market for mortgage loans. Congress created their charter in 1970.
They purchase mortgages from lenders across the country.
The mortgages they purchase are bundled or pooled together as mortgage-backed securities (MBS).
They guarantee timely payment of principal and interest to MBS investors and finance these purchases by issuing debt and mortgage securities. Investors value their guarantee and the homogeneous quality and liquidity of MBS over individual mortgages. Because of these attributes, investors in MBS are willing to accept a slightly lower yield as the funds pass through to them from us.
But not all the loans they purchase are packaged into securities; they retain some in their own portfolio. They get the funds to do this by selling bonds to investors throughout the world.
That’s how they ensure that there is a continuous flow of funds to mortgage lenders and provide low- to middle-income homeowners and renters with lower housing costs and better access to home financing.
Your bank isn’t taking a discount!
Be absolutely assured that your friendly neighborhood bank is not about to lend you $100,000 for the next 30 years and then turn around and sell that mortgage loan at a loss!
However if YOU take back seller financing and then try to sell it, be just as assured that the note buyer will want you to take a substantial discount.
What a note buyer may tell you
You will be told that a dollar today is worth more than a dollar next year. And this is absolutely true. This is why you are paid interest on your mortgage.
You will be told that the mortgage you have given means you don’t get paid for up to 30 years. And if someone has to wait 30 years for their money it is obviously going to be worth less to them. This is a half-truth. Firstly most mortgages are paid off within 7 years. Secondly you will be receiving principal and interest payments, hopefully, every month
You may be given an example to convince you.
They may put a $100 bill and a $10 bill down on the table in front of you and then ask you, “Which would you sooner have, the $100 bill or the $10 bill?”
Of course your answer would be the $100 bill.
“Now”, they will say, “How about if you could get the $10 bill today but had to wait a year to get the $100 bill?”
Perhaps you will still say the $100 bill in a year’s time.
“How about if you could take the $10 bill today but had to wait 10 years to get the $100 bill?”
Perhaps now you would say that you’d take the $10 today. If not, they’ll ask you the same question again, but this time with a 30 year wait.
“OK”, they will say. “So you DO agree that money is worth less if you have to wait for it.”
They will then proceed to tell you that your mortgage is only worth $xxx.
Now they are right that your mortgage may be worth less than face value, but not for these reasons.
Here is your answer when given the above argument.
“I’m confused. When I bought my house I got a 30-year mortgage from my local bank. I understand they sold that mortgage immediately to Fannie Mae.
Are you telling me that that they sold that mortgage to Fannie Mae for less than they lent me? Why would they do that?”
The true reason that the mortgage should be discounted.
