A partial buys the next stream of payments and leaves the balloon with the seller; it is safer than the whole note and far more sensitive to fixed costs.
A partial note is priced like a short annuity: discount the payments you are buying, net of servicing, at your required yield, then subtract the fixed costs of buying them. On an illustrative 9 per cent note paying $1,142.56 a month, the next 36 payments at an 11 per cent net yield, after $30 a month of servicing and $1,400 of costs, are worth $32,583.13. Those fixed costs are 4.3 per cent of the price, so the same purchase quotes a 15.82 per cent gross yield: on a partial, the costs decide the return.
Worked in full in The Mortgage Note Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A partial is a purchase of a defined number of payments, with the rest of the note, including the balloon, staying with the seller. Note sellers like it because they raise cash without discounting the back end. Buyers like it because less money sits in the same house. Both are right, and the arithmetic shows what each gives up.
| Input | Value |
|---|---|
| Original balance, rate, amortisation | $142,000, 9.00%, 360 months |
| Payments made / balloon due at payment | 26 / 84 |
| Monthly principal and interest | $1,142.56 |
| Unpaid balance today | $139,782.42 |
| House value (BPO) | $176,000 |
| Servicing fee, a month | $30 |
| Acquisition costs plus servicer boarding | $1,250 + $150 = $1,400 |
| Payments bought | 36 |
| Required net yield | 11% |
Partial price = (P&I − servicing) × (1 − (1 + y/12)−n) ÷ (y/12) − fixed costs
In Excel: =PV(11%/12, 36, -(PMT(9%/12, 360, -142000) - 30)) - 1400 returns 32,583.13. Typing the payment rounded to 1,142.56 gives 32,583.01: the difference is the unrounded cents.
Step 1, net the payment. The servicer keeps $30, so each payment is worth $1,112.56 to the buyer.
Step 2, discount 36 of them. At 11 per cent compounded monthly, 36 payments of $1,112.56 are worth $33,983.13.
Step 3, take off the fixed costs. $33,983.13 less $1,400 is $32,583.13. The buyer pays that, plus the $1,400, and receives $1,112.56 a month for three years: exactly 11.00 per cent net.
The 36 payments total $41,132.31 at face, so the partial is bought at a discount of $8,549.18. The seller keeps payments 37 to 58 and the $132,969.45 balloon, worth $94,219.78 at the same 11 per cent, of which the balloon alone is $78,325.62.
| Measure | Partial, 36 payments | Whole note |
|---|---|---|
| Price at 11% net | $32,583.13 | $126,802.91 |
| Investment-to-value | 18.5% | 72.05% |
| Fixed costs as a share of the price | 4.3% | 1.1% |
| Gross yield at that price, before costs and servicing | 15.82% | 11.57% |
| Cost and servicing drag, basis points | 482 | 57 |
On the collateral, the partial is much the safer position: $32,583.13 against a $176,000 house. But the same $1,400 of costs and $30 of monthly servicing that cost the whole-note buyer 57 basis points cost the partial buyer 482. The seller will quote the gross yield. The buyer earns the net one.
The default case shows the same thing from the other side. The whole note has a loan-to-value of 79.42 per cent, so a 20.6 per cent fall in the house price puts its $139,782.42 balance under water. Under a standard partial agreement the partial buyer is repaid first from any payoff, foreclosure sale or refinance, and needs only $32,583.13 of the $176,000 house to come back whole. The seller, holding the back end, carries almost all of the collateral risk, which is the real price of selling a partial instead of the note.
The partial agreement must say what happens on an early payoff. The usual clause pays the partial buyer the present value of the payments still owed, at the agreed yield, first out of the proceeds. If this borrower refinances at month 20, the buyer is owed $16,487.11 out of a $137,758.03 payoff, the seller receives $121,270.92, and the buyer's yield stays at 11.00 per cent. Without the clause, nobody knows.
| Payments bought | Price | Costs as % of price | Gross yield at the price | Net yield if priced ignoring costs |
|---|---|---|---|---|
| 12 | $11,188.18 | 12.5% | 39.31% | -12.84% |
| 24 | $22,470.75 | 6.2% | 19.90% | 2.89% |
| 36 | $32,583.13 | 4.3% | 15.82% | 6.50% |
| 48 | $41,646.69 | 3.4% | 14.22% | 7.96% |
Fixed costs do not shrink with the ticket. On a 12-payment partial they are 12.5 per cent of the price, and a buyer who priced the payments at 11 per cent and forgot them would lose money. That is why partials are usually written for several years of payments: the longer term spreads the same costs over more cash.
The common mistake is to discount the borrower's full payment at the target yield and stop. Priced that way, 36 payments of $1,142.56 at 11 per cent are worth $34,899.48. A buyer who pays that, then pays the costs and the servicing, earns 6.50 per cent, having overpaid by $2,316.35. On the whole note the same error costs far less, which is why investors who learned on whole notes are caught by it on partials. The second mistake is buying a partial with no payoff clause, which turns a fixed-income position into a negotiation.
Price a partial as the present value of the net payments bought, less every fixed cost: $32,583.13 for 36 payments at 11 per cent here. Read the result in two directions: an investment-to-value of 18.5 per cent, and a cost drag of 482 basis points. The note, the partial and the costs are live formulas in the free workbook for this case; the whole-note price on the same loan is worked in how to price a mortgage note for a target yield.
It depends on the partial agreement, which should say. The usual clause pays the partial buyer the present value of the payments not yet received, at the agreed yield, first out of the payoff. On an illustrative 36-payment partial paid off at month 20, that is $16,487.11 out of a $137,758.03 payoff, leaving $121,270.92 to the seller and the buyer's 11 per cent intact.
Usually, on collateral: the partial buyer has less money in the same house and is paid first. An illustrative 36-payment partial costs $32,583.13 against a $176,000 house, 18.5 per cent investment-to-value, against 72.05 per cent for the whole note. The trade-off is that fixed costs weigh four times as much on the smaller ticket.
To raise cash without selling the balloon at a discount. On an illustrative note the whole note sells for $126,802.91 at 11 per cent, 90.71 per cent of the balance; a 36-payment partial raises $32,583.13 and leaves the seller 22 payments and a $132,969.45 balloon, worth $94,219.78 at the same yield.
Chapters 2 to 5 of The Mortgage Note Investor price a performing owner-financed note with a balloon, its partial and its fixed costs; the free workbook carries every figure as a live formula. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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