What does "buying at a discount to face" actually mean in dollars

Question

I've read the phrase maybe forty times and I still can't picture the transaction. A note has a face value. Someone sells it below that. But which number is face? Is it the original loan amount, or what the borrower still owes now, or all the payments left including interest?

Someone in another forum said you buy a $100,000 note for $80,000 and "instantly make $20,000", which sounds wrong to me because the borrower isn't handing me $100,000 tomorrow. They're paying monthly for years. So where does the twenty go?

Also, if I buy the note, does the borrower know? Do they get a letter? Do I have to talk to them? I would rather not talk to them.

Rena Guide · Accepted Answer

Face value in note trading almost always means the unpaid principal balance, the amount of principal the borrower still owes today. It's not the original loan amount and it's not the total of the remaining payments. If a borrower originally borrowed $120,000 and has paid the balance down to $100,000, the note's face is $100,000 and a price of "80" means you'd pay $80,000.

The $20,000 isn't a windfall, and you had that right. Let me walk through where it goes. Suppose that $100,000 balance carries 7% interest with 20 years left, and the monthly payment is about $780. You paid $80,000 for the right to receive those payments. Over time you collect the interest plus the full $100,000 of principal, so the discount shows up as extra yield spread across the life of the loan. Your return on the $80,000 you actually spent works out higher than 7%, because you're earning 7% on a balance larger than what you paid. If the borrower refinances or sells next year and pays the loan off in full, you get the whole $100,000 at once and the discount arrives quickly instead of slowly. That's upside you don't control.

On your last question, yes, the borrower gets notified. When a mortgage loan changes hands, federal rules generally require notice to the borrower telling them who owns the loan and where to send payments, and your servicer handles that paperwork. A loan servicer is a licensed company that collects the payment, manages the escrow for taxes and insurance, and sends you the money, typically for a modest monthly fee per loan. You never have to speak to the borrower, and most buyers prefer it that way. Confirm the current notice requirements with your servicer in writing, since the details are specific and they do this daily.

gregpowell66 · Answer

The bit that finally made it click for me was thinking of it like buying a rent roll instead of a building. You're not getting a lump of money, you're getting somebody else's payment schedule at a markdown.

sonia_alvarez · Answer

Worth adding that "80" on a tape sometimes means 80% of unpaid balance and sometimes means 80% of the property value, and lazy sellers don't always say which. I've seen listings quote both in the same spreadsheet with no column header distinguishing them. Always ask which denominator, in writing.

marcus_hale41 · Answer

@vellum the early payoff point in the guide reply is the one that changes the math most. If you buy at 80 and the borrower refinances in month fourteen, your annualized return is enormous. If they never prepay and ride 20 more years, it's a decent but ordinary bond-like return. So your yield depends heavily on something you can't predict, and note sellers quote "yield to maturity" which assumes the boring outcome.

mitchell_ray4 · Answer

So the discount is compensation for risk, not free money. If the paper were riskless it would trade at face.

hannah_west29 · Answer

@solder mostly, though some of the discount is just illiquidity. There's no exchange for this stuff. You're paying someone to have already done the origination and the seasoning, and getting paid to accept that selling it again means finding a buyer one at a time.

megan_doyle15 · Answer

Dumb follow-on: if the borrower pays off early do I lose money compared to holding? Or is early always good when you bought at a discount?

joe_delgado5 · Answer

@rigging early is good on discount paper, since you collect the full balance you paid less than for. It's premium paper where prepayment hurts, meaning notes you bought above face because the coupon is high. Then a payoff hands you back less than you paid in and the interest stream you were counting on disappears.

dmitri_v6 · Answer

One document thing nobody's said: what you're buying is the note plus the mortgage or deed of trust that secures it, and those transfer differently. The note gets endorsed, often with an allonge attached, and the security instrument gets assigned by a recorded document. Recording practice and fees vary by state. If the chain of endorsements from the original lender to your seller has a gap, you can own a promise to pay with a lien you'll have trouble enforcing. Ask for copies of every endorsement and assignment before you fund, not after.

What does "buying at a discount to face" actually mean in dollars

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