Structured Settlement Factoring has been around for 18 years. In the 9 years I have been in the industry, I have heard and read some stories about our industry that are so absurd, you would think it was an Urban Legend. We hope to use this section to put to rest the misinformation that is consistently floating around about the structured settlement factoring industry.

I will start with the pricing issue that has been and still is the most misunderstood concept about our industry. The Urban Legend is that the factoring companies charge deep discounts to consumers. Like most urban legends, they started with some factual basis but the story has grown with time. The early years of the settlement factoring industry did have some high discount rates due to heavy expenses caused by costly litigation battles on individual cases and limited access to traditional investors. Once the Model Act was agreed upon and federal legislation came on board, interest rates began coming down dramatically, but the perception did not change.

Some of the confusion or misinformation lies within the terminology. There are several ways people explain the discount rate. First, there is the interest rate that is applied to the payment stream itself. The second option is the discounted present value. Finally there is the elementary school math where you take the purchase price and divide it by the total price of all the payments being purchased. Although all are expressed as an interest rate, they are all very different.

Interest rate as defined by Wikipedia is “the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. Interest rates are normally expressed as a percentage…” This is similar to an interest rate associated with home loans, credit cards and car loans. In a settlement factoring transaction, the factoring company knows the payment stream they are going to purchase and applies an interest rate to the payment stream itself and solves for the funding / loan amount. Interest rates from factoring companies to consumers can range anywhere between 9.5% up to 18%, but usually average somewhere in the middle. Interest rates can be a bit higher in factoring transactions opposed to home loans due to the fact the factoring transactions are more of a boutique product for investors opposed to the mainstream collateralized mortgage transactions.

The discounted present value as defined in the Texas transfer statute is the present value of future payments determine by discounting the payments to the present using the most recently published Applicable Federal Rate for determining the present value of an annuity, as issued by the United States Internal Revenue Service. The IRS discount rate, also known as the AFR or Applicable Federal Rate, is used to determine the charitable deduction for many types of planned gifts, such as charitable remainder trusts and gift annuities. The rate is the annual rate of return that the IRS assumes the gift assets will earn during the gift term. The IRS discount rate is published monthly. You will find the current available IRS discount rates here.

The term “discounted present value” has no bearing on the actual pricing of a factoring transaction. Some states will require a quotient to be listed on the disclosure that is sent to the customer prior to entering into a contract with a factoring company. The quotient is calculated by dividing the purchase price by the Discounted Present Value. The quotient provides no relevance in the pricing of a settlement factoring transaction either, yet some state transfer laws require it to be listed in the disclosure.

Finally, the most overused and insignificant value associated with “deep discounts” is the concept of dividing the purchase price by the total value of all the future payments added together and describing it as a percentage. The fact that the concept of time is completely disregarded in this equation should be enough evidence to dispel any comments using this illogical percentage as a true representative discount. If this logic was used when buying a home, then every homeowner who takes out a 30year mortgage is getting hit with “Deep Discounts.” Some mortgage companies are currently offering a 30year fixed rate at 6.48%. On a $150,000 loan / home price with a 6.48% nominal annual rate compounded monthly, you would be paying roughly $946.13 for 360 months (this does not include PMI or any additional insurance that may be required) for a grand total of $340,606.80 over the term of the loan. Applying the illogical formula of discounting from above ($150,000 / [$946.13 x 360]), the discount rate would be 44%, but you never hear anyone complaining about mortgage companies charging “Deep Discounts?”

Interest rates, discounted present value and the purchase price divided by the total value of all future payments all share the commonality of being displayed as a percentage, but at the end of the day, they do not tell the whole story. Hopefully when the topic of structured settlement factoring rates are discussed, everyone will have a better understanding of what type of “discount rate” is being implied in the conversation. The concept of factoring companies applying “deep discounts” really is an outdated misconception that has turned into an urban legend.