The Discount Arbitrage: Buying at 75, Selling at 95

Part 6 of 15  ·  The Scratch & Dent Strategy

The Discount Arbitrage: Buying at 75, Selling at 95

The core engine of the S&D strategy is the discount arbitrage — buying an asset based on its flawed present state, fixing the flaw, and valuing it based on its cured future state.

The Scenario: A regional bank originates a $250,000 mortgage at 7% interest to a borrower with a 740 credit score. The title company misses a signature on one disclosure. Fannie Mae rejects the loan. The bank needs to clear it by quarter-end.

$250,000

Par Value

The face value of the perfect, performing loan (100%).

$187,500

S&D Purchase Price

You acquire the defective note at 75 cents on the dollar.

$237,500

Cured Resale Value

After curing the defect, you resell to an aggregator at 95% of par.

The Two Profit Centers

Capital Gain (The Flip): You spend 60 days tracking down the missing signature and perfecting the file. The loan is cured. You sell it to an institutional aggregator for $237,500 — capturing a fast $50,000 gross profit.

Yield Amplification (The Hold): You keep the note. The borrower pays 7% interest on the full $250,000 balance ($17,500/year). Because you only paid $187,500, your effective cash-on-cash yield jumps to over 9.3%, secured by first-position real estate.