Impact of Costs on Note IRR

[Omri Liba]

Hi,

I use two techniques to financially evaluate notes:

1. Through the RATE() function in Excel, without considering the costs relating to the note
2. Through an Excel sheet that i built that takes into account servicer costs, set-up and closing costs, taxes (17.5% for me as a foreign investor), and other such costs

The issue is, that often method #2 gives an IRR which is 3% lower that method #1.

Just as an example - a note from FCI with ~160 terms left, a rate of 7%, monthly payments of $404.4, and a selling price of ~$30k gives an IRR of ~14.4% in method #1, and ~11.5% in method #2.

My question is - is that normal for the IRR to lose that much due to the costs associated with the investment (servicer, taxes, closing costs,...)?

Thanks!

[Dion DePaoli]

Not sure what you are plugging in to get your numbers but with the inputs you list my results are different:

=RATE(160,-404.40,30000,0,1%) = 1.12% or 13.46%

If you take the monthly servicing fee out you would net that from the payment. So simply reduce the $404.40 by X where X is the cost per month of servicing the loan. So if that is $15 then the IRR is 12.68%.

Boarding fees, due diligence fees and other costs to purchase would simply increase the PV.  So instead of using the purchase price of $30k it would be purchase price plus servicing $80 plus any due diligence costs plus the 1% FCI fee, etc.  

Yes, adding those items in will reduce the IRR.  Yes, that is normal.