One of the most overlooked aspects when a seller provides owner financing is the agreed interest rate. That rate can have a significant impact on the value of the note. Each year many sellers simply overlook this one decision and it can have an impact on the financed note.
Interest Rates and Seller Financed Notes
Why Do Interest Rates matter with Private Mortgage Notes?
1. Staying Ahead of Inflation
The cost to buy basics each year is steadily on the rise because of inflation. With interest rates jumping as high as 5% each year, it can be difficult to keep your cash flow on the positive. During that same year, energy basics can jump as high as 29% in that same year. This is why it is so important to make sure you understand the interest rate of the note so the minimum rate is equal to the current rate of inflation. This will ensure if nothing else you are at least breaking even.
2. Investment Return
You don’t want to invest all your time and efforts however just to break even, the name of the game is getting a return on your investment. When you accept payments from the buyer, you are in a sense tying up that money. If the home is eventually sold then the new owner will greatly benefit if there was an increase in the property value. Because the seller is in a sense acting in part as the bank would, they should expect a decent return that is equivalent to an interest rate charged by the bank for a loan of similar value. As a seller you do not get the protection of mortgage insurance like the banks require, so you should at least be rewarded with the increased interest rate.
The buyer is in a sense saving all those added costs like underwriting fees, points, origination fees, and more that the bank traditionally charges. Therefore it is only reasonable to think that they should pay an interest rate that is more than the bank would charge. The recommended interest rate on a seller financed note should be 2-4% higher than the bank rates for a similar note.
3. Improved Resale Value for Note Buyers
In the event the note holder decides to sell the future note payments, that is when they will realize how important that interest rate increase was. If the seller was holding a note that still had a balance of $100.000.00, you could expect the following:
Balance of Note – $100,000.00
Monthly Payments – $1,110.21
4% Interest Rate = $81,623.00 Offer
6% Interest Rate = $87,641.00 Offer
8% Interest Rate = $95,274.00 Offer
You can see by this example that a 2% increase or decrease in the interest rate can have a significant difference on the final offer of the note. basically the higher the interest rate, the higher the value of the note.
4. No Do Overs
Once you sign the papers on the note the deal is done, there is no do overs because you decided today that a better interest rate would benefit you down the road. The interest rate agreed upon at the signing of the note stays with the note until it is sold. Be certain to negotiate a fair interest rate while the option is still available because it will not only affect the overall value of that note today, it will carry over through the life of the transaction.
