If you’re interested in seller financing or ready to sell your note, the terms ‘face rates’ and ‘discounts’ are probably words you have heard thrown around. If they aren’t, here’s an important quick overview.
What is the Face Rate of a Note?
Also known as the ‘present value,’ the face rate is simply the interest rate on the note and mortgage.
The ideal face rate for a note depends on which party you speak to. Buyers, understandably, prefer lower interest rates. Investors prefer higher interest rates.
Why? Because, the higher the face rate, the lower the discount when selling…
What is a Discount on a Note?
The discount on a note is the difference between how much the investor ideally wants to earn versus what the face value is.
Confused? Let’s look an example.
Say you are selling a note with a face rate of 8%.
The investor, in this example, is looking to earn 12% on their note investments.
Since we can’t go back and change the terms of the note, the investor must pay LESS money for the overall balance due. In other words…
…if the investor paid 100 cents on the dollar, they would earn 8%. But, if they pay 92 cents on the dollar (for the same debt owed) they will earn the required 12%.
Again, discount is really the difference between what the investor requires and the face rate of the note.
It’s important to remember that the face rate of a note cannot change unless explicitly written into the original agreement. Additionally, the payment and amount financed never change for the payer (unless the investor and home buyer strike a mutual agreement).
Seller Financing and Face Rates
An average face rate ranges from 8% to 12%. While a high rate is ideal for profit and potential sale down the road, it’s important to take your state’s usury law into account.
A usury law dictates how high an interest rate can be on a mortgage note. If your offered rate is higher than allowed, it is no good to potential investors.
While higher is better, remember there is also too high.
Thinking of Investing in Notes?
First, ask yourself what you want to gain.
One advantage of the note industry, assuming not having collection problems, is to pre-determine a return in advance.
But, always remember the Time Value of Money (TVM).
TVM, states that money at the present time is worth more than money in the future due to the potential earning capacity.
Overall, private sellers and investors have more leeway than banks do…in a good way! But, they still need to take into account what interest rates will work. Investors looking to buy notes need to keep in mind their required discount, appetite for risk, and of course the yield of their investments.