Hypothecation Deal Math: A Complete Walkthrough

Margaret's first call is to a note buyer. Here's how that conversation goes.

The buyer looks at Margaret's note and sees a 4.5% interest rate. That's well below what they need to earn. To turn Margaret's 4.5% note into the 12% yield they require, they can't pay her the full $279,265.95 balance. They have to pay less.

How much less? Let's do the math.

Margaret's note pays $1,520.06 a month for 312 remaining months. A buyer who needs a 12% return runs those payments through a present value calculation and arrives at $145,189.02. That's what the note is worth to the buyer.

Margaret's note has a balance of $279,265.95. The buyer is offering $145,189.02. That's a discount of $134,076.93, nearly 48% off the balance.

But we're not done. When Margaret sells, the IRS treats it as a capital gains event. At a 20% capital gains rate, she'd owe roughly $29,037.80 in taxes on the sale.

So here's Margaret's real math if she sells:

• Balance owed to her: $279,265.95
• Buyer offers: $145,189.02
• Capital gains taxes (20%): $29,037.80
• Margaret walks away with: $116,151.21

She gets $116,151.21. That's not even enough for the $125,000 her daughter needs. And here's the part that nobody mentions: she also gives up $1,520.06 a month for the next 26 years. That's $474,258.72 in future income. Gone. All of it.

We're not saying note buyers are doing anything wrong. They're pricing risk, and their math is sound. A 4.5% note requires a significant discount to produce a 12% return. That's just how present value works. The question is whether selling is the right move when you only need a portion of your note's value.

For a deeper look at how buyers price notes, see our guide on how note buyers determine what they'll pay. For the tax side, see taxes when selling a mortgage note.

Same Margaret. Different path.

Instead of selling, Margaret uses her note as collateral for a loan. Here are the terms:

• Loan amount: $125,000
• Interest rate: 12%, interest-only
• Term: 24 months with balloon
• Origination fee: 3 points ($3,750)
• Admin fees: $870 ($575 underwriting + $250 UCC filing + $45 wire)

Margaret's monthly life during the loan:

Every month, Margaret's borrower sends $1,520.06 to the servicer. The servicer forwards it to Margaret. Margaret pays us $1,250.00 in interest. She keeps $270.06.

Let that sink in. She's cash-flow positive the entire time. Her note income covers our payment with $270 to spare, every single month, for the full two years.

Total cost over 24 months:

• Interest payments: $1,250.00 x 24 = $30,000
• Origination fee (3 points): $3,750
• Admin fees: $870
• Total cost: $34,620
• Taxes owed: $0

It's a loan, not a sale. There's no taxable event. Margaret doesn't owe the IRS a dime.

At payoff (month 24):

Margaret repays the $125,000 principal. We release the UCC filing and return her original note. She still owns her note, which now has 288 payments remaining and an unpaid balance of $267,415.46. She's still collecting $1,520.06 a month. That's $437,777.28 in future income, still flowing to her.

The total cost of getting her daughter's $125,000? $34,620. That's it.

For a complete explanation of how hypothecation works, see our guide to note hypothecation.

Here's Margaret's choice, laid out plainly:

If she sells:

• Cash Margaret receives: $116,151.21
• Total cost (discount + taxes): $163,114.74
• Monthly income after: $0
• Still owns the note? No
• Future income remaining: $0

If she borrows against the note:

• Cash Margaret receives: $125,000
• Total cost (interest + fees): $34,620
• Monthly income after: $1,520.06 continues
• Still owns the note? Yes
• Future income remaining: $437,777.28

The difference in total cost? $128,494.74. That's what Margaret saves by not selling.

Margaret kept her note. She kept her income. She helped her daughter. And she still has a $267,415 asset paying her $1,520 a month for the next 24 years. That's the math.

We'd rather tell you about the risks ourselves than have you find out from a forum post. Here's what can go wrong, and how we think about each one.

"What if Margaret's borrower stops paying?"

If the homeowner defaults, Margaret stops receiving income and may struggle to make payments to us. This is real risk. It's exactly why we underwrite the underlying note before we lend against it. We check property value, LTV ratio, 12+ months of payment history, insurance, and property taxes. We don't lend against shaky notes. Margaret's borrower has 48 months of perfect payment history on a property with solid equity. That's the profile we look for.

"What if Margaret can't repay us?"

Ownership of her note transfers to us. That's the collateral structure. We don't take her house. We don't come after her personally. There's no personal guarantee. We take the note. It's also why we never lend more than 50% of the note's value and 50% of the property value. Even in a worst case, there's a cushion for everyone.

"What if she needs more time?"

Extensions are available at 1-2 additional points, same rate. From our experience, about a third of borrowers pay off early, half pay at maturity, and the rest extend. We're not in the business of pressuring people. If Margaret needs another six months, we can work that out.

"Why is the interest rate 12%?"

We're making a specialized loan against a non-traditional asset. Traditional banks won't do this because they don't understand notes. Our rate reflects the cost of capital, the underwriting involved, and the risk profile. The important comparison isn't our rate versus a bank mortgage rate. It's the total cost of our loan ($34,620) versus the total cost of selling ($163,114). That's the number that matters.

Margaret's deal is one example. Your note has different terms, a different rate, a different property behind it. The math will be different, but the structure is the same.

If you're holding a note and wondering whether you can access cash without giving it up, tell us about it. We'll put together a complete proposal with your specific numbers: what you'd receive, what it costs, and what your monthly cash flow looks like during the loan. No obligation, no pressure, no follow-up calls unless you want them.

Just the math. That's all we're offering, and it's all most note holders need to make a confident decision.

To understand how this process works from start to finish, see our complete guide to note hypothecation. To explore other options, see 5 alternatives to selling your mortgage note.