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Let’s say I have a loan at 3% for 10years for $100,000. After one year rates in the Loan market rise and are at 6% for the same type of loan. Why wouldn’t the payoff amount of the loan be discounted similar to a bond with lower yield than current market rates.

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    Payoff is what you owe. That's their money, the money that you borrowed. The interest is what you paid to borrow it.
    – user26460
    Commented Nov 6, 2023 at 21:44
  • The discount is just off the interest portion, to make up for the other bank taking over the hassle of dealing with the customer. The lending bank still makes a profit, but with less work and they get the money sooner. Short if paying off the loan, I don't see any way you can make that deal.
    – keshlam
    Commented Nov 8, 2023 at 4:02
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    I feel like the answers so far are side-stepping the actual question. My guess is the real answer is something like "Banks aren't allowed to offer the same deal to the debtor, perhaps due to a law preventing it, because if banks were allowed to do it, all hell would break loose once it became common knowledge." On a related note, I think when loans are sold, they are sold in groups, and I wonder if that's done in part to protect against this proposed scenario.
    – TTT
    Commented Nov 13, 2023 at 21:36
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    In the Danish bond based mortgage system, debtors do have the option of buying out their mortgage at the market rate (if that's lower than face value). Commented Jan 17 at 15:18

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Theoretically, this could certainly work. Practically, however, it doesn't.

The bank that originated your loan almost certainly packaged your loan with hundreds of other loans and sold it to an investor a few days after it closed. The bank doesn't want to hold your mortgage and get payments every month for 30 years. It wants to sell the asset off quickly so that it can get money in its hand that it can loan out to the next borrower. Banks don't want to hold a bunch of mortgages on their books whose value is going to rise and fall with interest rates.

Investors, on the other hand, are quite happy to own portfolios of mortgages. If you're running a large pension fund, for example, you're likely to regularly buy bundles of mortgages (called mortgage backed securities) that produce income you can distribute to your current retirees.

Practically, it would be very difficult for an individual to buy back their mortgage at that point. Sure, you're $100k mortgage is now only worth $85k. But it has been bundled with thousands of other mortgages into a security and that security is now owned by a large pension fund. It would be deeply impractical to say "OK, my loan on 123 Evergreen Terrace has been packaged into a mortgage backed security MBS881234 that is owned by CalPERS to pay pensions to teachers. I'd like to break apart that security into its individual components and buy just my mortgage from CalPERS". Even more so when you realize that shares of the security could be owned by different investors, there may be derivitives related to the security, etc.

And there are a bunch of concerns about fairness that would arise. If three borrowers all got identical $100k loans on three neighboring houses on the same day, one borrower's loan might be held by the originating bank in their investment portfolio, one might be held by a quasi-government entity like Fannie Mae, and one might have been packaged into a security that is held by a private pension fund. Fannie Mae might be happy to sell the loan back to the borrower. The bank may be able to sell the loan back but may prefer not to. The pension fund may not practically be able to sell the loan back and may not want to do so if they could. If the three identically situated borrowers have to deal with three very different results, that could be a major fairness issue. Particularly when banks might "just by luck" hold on to the mortgages of politicians and other VIPs that they happen to want to sell back when rates go down.

Theoretically, you could have a very different mortgage business where what you propose would be possible. Banks could be forced to hold the mortgages they originate forever and allow you to buy them back at their fair-market value. That would put bank balance sheets under tremendous pressure when interest rates are rising which would likely make long-term fixed interest rate loans untenable. It could cause lots of bank failures (recall that Silicon Valley Bank went under because it held a bunch of very safe government bonds that dropped in value when rates increased). And in order for banks to get the money they need to keep lending, they'd need to borrow against the mortgages they're obligated to hold. A private lender wouldn't lend 100% of the value of the pledged collateral and would require additional collateral when rates increased and the value of the original collateral declined which would limit the amount of money banks would be able to get in order to lend on new mortgages. That would tend to make it much harder for people to get new mortgages.

And if you had done all this work to completely restructure the mortgage market, the vast majority of borrowers would be in more or less the same place. Borrowers took out the $100k loan initially because they didn't have $100k. If the value of their loan drops to $85k, they almost certainly don't have that money laying around, they'd have to go borrow it. If a $100k loan at 3% has the same value as a $85k loan at 6% then the borrower should be indifferent between the two. It would be better for the minority of borrowers that pay the loan off early without refinancing. But that is a rather small minority of borrowers.

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  • I think this answer is too institutional-based / esoteric to be of value to the borrower. Simplistically - to buy out their own mortgage at a discount, they would need the cash to do so [if they would need to refinance, then market conditions allowing for a discount, would imply that refinancing would be more expensive a rate than their current mortgage]. Thus the remainder of the answer does not appear to apply and distracts from the simplest issue - that the borrower is still liable for the full balance owed. Commented Nov 14, 2023 at 18:09
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    But theoretically, the OP is right. If the $100k loan only has a current value of $85k, you could envision a system where the borrower could go buy that loan for $85k today rather than paying off the balance over time. It happens that this is not a practical option given the current institutional needs of banks, governments, etc. But it is in theory something that you could set up the system to allow Commented Nov 14, 2023 at 18:19
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    @Grade'Eh'Bacon The way I read the question, I feel that OP fully understands what the borrower is liable for, and instead was asking a hypothetical question about what incentives prevent banks from offering the same deal to the borrower that they would accept from another bank. With that interpretation of the question, I think this answer is valuable, particularly the 3rd paragraph which gives a pretty straight forward reason why banks shouldn't do it, because if they did it would necessitate jacking up fixed term rates for everyone, to price in the risk of rates going up.
    – TTT
    Commented Nov 14, 2023 at 18:20
  • @JustinCave While true, I think that misses the point to the individual borrower / the OP. The fundamental element here is simply noting that when this scenario exists [bank would sell your loan at a discount to someone else], the borrower has already 'won' - you have a fixed rate debt at a lower rate than the prevailing market rates. Short of being able to actually pay off this debt at the reduced rate, if you have the cash available, consider that you have the ability to invest with leverage at a lower rate than it would cost to take that leverage today. Commented Nov 14, 2023 at 19:17
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    Realistically, if you have the cash available to consider buying off your mortgage, that heavily implies you already got a higher mortgage than strictly necessary for the sake of liquidity / leverage, and therefore your decision is the same now as when you decided to get a mortgage when you could have instead increased your down payment [except now your fixed rate debt looks more attractive relative to the market]. If you don't already have the cash available - that just means be happy about having a lower rate debt than what it would cost today. Commented Nov 14, 2023 at 19:19
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Why wouldn’t the payoff amount of the loan be discounted similar to a bond with lower yield than current market rates.

You're confusing the yields to investors with debt obligations. When a bond is sold between the investors on the market, the obligation of the debtor doesn't change. Whether the bond sells with a premium or a discount doesn't change the par value or the coupon value.

Similarly with your loan - the investor which owns it can sell it, and in this situation probably at a discount to compensate for the lower rate. But you as a debtor will continue paying it off as per the loan schedule.

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  • If the loan is being sold at discount to another lender why wouldn’t the same offer be given to the debtor? Commented Nov 6, 2023 at 17:29
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    @DungenessCrab the debtor signed a contract and should follow the terms of the contract. I'm not sure why it would matter to the debtor who owns the debt on the other end.
    – littleadv
    Commented Nov 6, 2023 at 17:50
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    If you don't like this possibility, you can risk a variable-rate loan. But that puts you at risk if rates go the other way. If you take a fixed rate loan, the way to change the rate is to refinance. (I did so twice on my mortgage, dropping about three percentage points from initial loan to final.)
    – keshlam
    Commented Nov 6, 2023 at 18:51
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    @DungenessCrab You can call your loan holder and ask for discounted payoff. They'll probably say no. However, if the loan holder is a collection agency or long-delinquent credit card, they just might say yes. In fact, I would never payoff a collection agency for the full amount, because they often will take a lower amount for 100% payoff.
    – user26460
    Commented Nov 6, 2023 at 21:45
  • @DungenessCrab In principle you could be made the offer to buy the loan at the same price as anyone else. After you bought it you don't need to pay back anything anymore. However the general assumption is that you don't have the money to buy the loan. If you were to take a new loan at the current rate your finances wouldn't really change.
    – quarague
    Commented Nov 15, 2023 at 20:15
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I think there are two main reasons this doesn't happen.

Firstly, it'd be a lot of admin hassle for them to offer a buyout to individual borrowers. They'd have to deal with any relevant consumer regulations, organise the transaction with you, etc etc. If they sell many loans them in bulk to a company that's used to doing this, it'll be a lot less effort.

Secondly, there's always some chance you'll repay some or all of the loan early. Maybe you move house, maybe you don't realise what a great deal you have, maybe it's not such a great deal for you because you can't get that much interest on your savings even though a new loan would be even more expensive.

If they're selling lots of these loans at once to someone disinterested, the buyer can just estimate the likelihood of that happening and apply it as an average across the whole portfolio.

But if they're selling them to you, then adverse selection comes into play. Suppose you owe $100,000 and the "market value" if the loan was kept till maturity is $85,000. En masse, maybe someone will pay $90,000 because of the chance that you'll repay early. But you have a much better ability to estimate the change that you will repay early, and you might only take the $90,000 deal if the chance is higher than average. So they'll end up losing money on the deal.

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The bank gave you $100,000 for signing a contract that you pay them $1000 a month for the next 100 months, plus 1/12th of 3 percent of the outstanding loan every month. That contract was worth $100,000 plus profit to the bank when they sold this.

Today, the bank could get a contract where someone pays 6% and today that contract would be worth $100,000. Your contract is worth less today. Roughly $15,000 less or so. If they try to sell the contract they will only get $85,000.

Now if I signed my contract today, and next year interest rates go down, my contract would be worth $115,000. But I would like to repay the loan for $100,000 if I inherit money for example. You would like to repay your loan for $85,000. We can’t both get what we want.

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    "We can't both get what we want." and I'd add "at the same time." They both can get what they want at different times. But at the present time, if the bank is about to sell the 3% loan in a 6% market for say, $85K, it would be in the bank's best interest to accept, say, $90K from the lendee instead, if the lendee had the means of paying off the mortgage today. (Assuming the transaction is done in a vacuum and it's either $85K or $90K to dump it.)
    – TTT
    Commented Nov 13, 2023 at 23:31
  • That "today" is critical, though. And figuring the time-value of early payment is... messy.
    – keshlam
    Commented Nov 14, 2023 at 1:50
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If you can afford to buy your own loan, it's usually easy. Just pay off the principal. You'll immediately save all the future interest you would have paid, which is equivalent to getting a discount.

If you don't have the money to do that, you probably couldn't buy your loan anyway. It's generally being discounted from its theoretical value with interest, not its outstanding principal; the lender still wants to make a profit while reducing the cost of continuing to service the loan themselves. The only time it might be sold below the principal would be if the bank really feared they would be unable to collect from you and wanted to turn you over to someone who is more willing to apply strong-arm tactics.

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  • If interest rates rise [meaning the current holder of the loan would need sell it at a discount, relative to the higher interest income potential of higher rate new debt], that is the worst time time refinance - because it would mean that you would be refinancing when interest rates are higher. Commented Nov 13, 2023 at 21:06
  • Thought that was self evident. You refinance when by doing so you can lower the cost of the loan without lengthening it.
    – keshlam
    Commented Nov 13, 2023 at 21:10
  • (or shorten the time to pay off without increasing payments. Or some other tradeoff that saves you money. Or occasionally that costs but bring the payments down to leave you more money to do other things with.)
    – keshlam
    Commented Nov 14, 2023 at 1:47
  • I think your answer implies that if your current bank would be able to sell off your loan at a discount, you could try to refinance - rather, getting a refinance at this time is likely going to increase your costs. Given the OP's level of understanding, I think throwing in the general concept of refinance, when it won't apply here, has the potential to be misleading. Commented Nov 14, 2023 at 14:30
  • You may be right..
    – keshlam
    Commented Nov 14, 2023 at 17:07

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