Yield to Maturity

Yield to maturity (YTM) is the total annualized return an investor would earn on a mortgage note if they purchase it at a given price and hold it through the borrower's final scheduled payment. YTM accounts for the purchase discount (or premium), all coupon (interest) payments, the return of principal over time, and the time value of money — collapsing all of these factors into a single annualized percentage. It is the most widely used metric for comparing performing notes with different coupon rates, remaining terms, and purchase prices on an apples-to-apples basis.

How YTM Is Calculated

YTM is the discount rate that makes the present value of all future cash flows from a note equal to the purchase price. In practice, it is solved iteratively (there is no closed-form algebraic solution for most amortizing loans). The formula in concept:

Purchase Price = Sum of [ Payment(t) / (1 + YTM)^t ] for each period t from 1 to n

Where:

• Payment(t) is the scheduled monthly payment (principal + interest) in period t
• n is the total number of remaining payments
• YTM is the monthly yield (annualized by multiplying by 12 or compounding)

Most investors use a financial calculator, spreadsheet (Excel's RATE or IRR function), or note-pricing software rather than solving this by hand.

YTM in Action: A Practical Example

Consider a performing first-lien note with these terms:

At the 6.5% coupon rate, the borrower pays $569.92 per month. But the investor paid only $63,750 for a note with $75,000 in remaining principal. That 15% discount means the investor receives more value over time than the coupon rate alone suggests. Running the YTM calculation on this note produces approximately 8.5% — meaningfully above the 6.5% coupon rate.

The deeper the discount, the higher the YTM. If the same note were purchased at 75% of UPB ($56,250), the YTM would jump to roughly 10.8%.

YTM vs. Other Return Metrics

Understanding how YTM compares to other yield measures helps investors use each one appropriately:

YTM and IRR will produce the same result when the note is held to maturity and every payment arrives on schedule. They diverge when payments are irregular, the note pays off early, or the investor sells before maturity.

Assumptions and Limitations

YTM is a powerful comparison tool, but investors should understand its built-in assumptions:

• No default — YTM assumes every payment is made on time. If the borrower falls into default or the note becomes non-performing, actual returns will differ from the calculated YTM.
• No early payoff — YTM assumes the note runs to its full maturity date. In reality, many borrowers refinance or sell the property before the loan term ends. An early payoff on a discounted note actually increases annualized returns because the investor receives the full UPB sooner. This is why some investors also calculate yield to earliest expected payoff.
• No reinvestment assumption — YTM does not account for what the investor does with received payments. It assumes cash flows are received but does not model reinvestment at any particular rate.
• Balloon payments — Notes with balloon provisions have a large lump-sum payment at a specific date, which concentrates a significant portion of the return at one point. YTM handles this correctly in the calculation, but the investor faces risk that the borrower cannot make the balloon payment.

Using YTM to Price Notes

Most note investors work YTM in reverse when making offers: they start with a target yield and solve for the purchase price that achieves it. For example, if an investor targets a 10% YTM on a performing first-lien note, they can input the note's coupon rate, remaining term, and payment schedule into a calculator and solve for the maximum purchase price. This approach — pricing to a target yield — ensures the investor's offers are consistent across different notes and aligns purchase decisions with their portfolio return requirements. The target YTM should reflect the note's risk profile: a first mortgage from a creditworthy borrower warrants a lower target YTM than a second mortgage with higher LTV and greater default risk.