Discounting of Mortgages
Buying for less than the face value is called buying at a discount. You may have encountered a term like "discounted mortgages" and wondered what it meant. This is it. If a note can't be bought at a discount, there is no profit and no reason to buy. From the lenders point of view the time value of money states that by paying cash today to receive cash tomorrow, the lenders has to get a discount because they have to wait to collect their money. The longer the lender has to wait to get his/her money back, the less they can pay today. The cash discount is the sale of the paper (note) at a reduced price to enable the lender to have an overall yield greater than the contract rate on the mortgage. This cash sale of paper can occur at any time after the mortgage is written and up until the date due is satisfied. A mortgage which has some maturity is considered to have a performance record, and hence may be discounted less than if it had no record of payment. Mortgages discounted in the early years will generally have an additional penalty for this lack of seasoning. This will depend on the type of mortgage and the position in rank. It is obvious that a second mortgage will not be as saleable as a first mortgage on the same property. Therefore, it may require a greater discount. Discounting is the reverse of compounding, but many people have a hard time understanding this. Using our savings bond example (in time value of money) when we bough a $100 bond for $60, the $100 face value was discounted 40 percent ($40) because we were buying the future value of $100. We have to wait twenty years to get the face value.
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