When is 8% Better Than 12%

[Chris Seveney]

I have this conversation frequently with investors investing in mortgage notes and private lending. Many people will look at the interest rate or even the yield to determine which is a better deal. But what many forget is when using yield it assumes you are reinvesting the money you receive every month back at the same rate, which when lending we know this is not the case. Here is a great example:

Investor A does a $25k private loan at 8% interest only for 4 years. They collect $2,000 per year interest and the balance at end of 4 years so they collected $33,000.

Investor B does a $25,000 loan amortized over 4 years. This pays $658.35/mo = $7900/yr but over the course of the loan only $6600 in interest. This then has them collecting $31,600 total after 4 years. Now some of you may say well yes they can reinvest that $7900 every year, but in real estate its difficult to invest $650/mo including the time you are spending on it. 

Why share this? The reason being I see a lot of people again just looking at one specific number and not understanding everything behind it.