Do Rising Interest Rates Make Selling Your Note a Better Way to Secure Cash for Personal Needs?
During the financial crisis of 2008, the Federal Reserve lowered the federal funds rate. This meant the prime rate – the interest rate on which banks base their lending rates for consumers – was lowered as well. They did this to encourage banks to lend money and spark economic growth.
As the economy improved between 2008 and 2015, the Federal Reserve has gradually increased the federal funds rate. In fact, they have raised it six times since 2015. There are at least two more planned for 2018.
How Will Rising Interest Rates Affect the Economy?
The fact that the Federal Reserve plans on raising rates has implications for all sorts of aspects of the economy. In short, it means it will be more expensive to borrow money and more beneficial to save. Some of the most common effects of rising interest rates are:
- Credit cards and other short-term loans will see higher rates because short term borrowing is seen as riskier. This means a higher chance that borrowers might default.
- Auto loans and other longer term borrowing may rise modestly.
- Mortgage rates are not affected as much by rising interest rates. However, if inflation rises it will drive mortgage rates higher and fewer people may be able to afford to purchase homes.
- Savings rates typically increase, because people will earn a higher amount of interest on their savings balances.
- Consumer spending drops because people are saving more, and don’t want to spend as much paying back purchases made on higher rate credit cards.
What Do Rising Interest Rates Mean for People Who Own Mortgage Notes?
If you are someone who’s provided seller-backed financing on a home that you owned, you probably entered into that agreement sometime in the last few years.
And if your buyer was someone who decided on seller-backed financing because their credit didn’t meet the stricter lending standards in place since the housing market crash, you probably settled on an interest rate that was somewhat higher than the banks were offering. Which allowed you to make a decent return on your investment each month.
Over the last few years, interest rates on mortgages for buyers with excellent credit range from about three and a half percent to four and a half percent. Meaning you might be earning six or seven percent or more in interest on your seller-backed mortgage.
But now, with interest rates rising, you might wonder what that means for you? And how it might affect a potential decision to release yourself from the seller-backed mortgage note you’ve been carrying?
There are two reasons a seller might want to move away from the seller-backed mortgage investment. They include an unexpected need for a lump sum of money. Or a desire to invest in a more liquid investment or one that provides a better rate of return. We’ll discuss both reasons below in the context of the potential impact of rising interest rates.
What if You Need Cash?
A steady monthly income earned from the interest on a seller-backed mortgage loan is great! Unless you find yourself in need of a large sum of cash and you have no other savings to pull it from.
It’s possible that you could secure a personal loan, but there are downsides to this:
- You’re at the mercy of a bank in regard to how much money you can borrow
- There may be additional fees associated with borrowing the money
- Paperwork and due diligence required by the bank can end up costing you time and money.
Most important is the fact that, as interest rates rise, it’s going to cost you more to borrow the money you need!
Think about it. Personal loans right now are subject to about a 10% interest rate on average according to bankrate.com, and as interest rates rise, so will this number. A cash advance line from a credit card presents the same situation.
Let’s look at an example. Say you only earning six percent from your seller-backed mortgage. But you borrowed money from a bank or took an advance on a credit card. You’ll now be paying considerably more in interest on your loan than you’re earning from your investment and you’ll end up losing money.
Selling your note, or even part of your note, can provide you with the money you need. As mortgage notes are worth more in times of lower interest rates. Also, you are likely to receive more money for your note now than waiting until after rates have begun to rise.
Unlike traditional borrowing, you can get the proceeds of your mortgage note sale much faster, and most important, it won’t cost you the interest you’d be paying if you borrowed the money – interest that will only continue to be more expensive as rates rise.
Could You Earn More Money in Another Investment?
With rising interest rates, the interest rates on savings accounts, certificates of deposit (CD’s), and other similar savings vehicles will increase as well.
Currently, the best savings rate is hovering around two percent. And the best certificate of deposit rate is between two and two-and-a-half and three percent.
The Federal Reserve has indicated it will raise rates at least two more times this year, possibly three. Each time they raise the rate, it’s usually by about a quarter percent. If rates keep rising over the next few years, savings rates will end up being pretty attractive. Additionally, they may represent a better return on investment than what you’re earning on your seller-backed mortgage note.
The biggest advantage to putting the money into another investment is that some other investments. Like savings accounts and stock investments, they are more liquid. You might pay taxes on the withdrawal, but you can access your money pretty quickly if you need to.
And suppose you wanted to use the money to invest in another real estate opportunity? Even though this doesn’t offer the liquidity of a high-yield savings account, it could still provide you with more income than you’re making now.
If interest rates rise, and inflation rises with it, mortgage rates will increase as well. By swapping out your current note for a real estate investment that’s earning a higher rate because of rising interest and inflation rates, you could end up earn a better interest rate on a new real estate venture, and more money in your pocket each month.
The next meeting of the Federal Reserve in June will give yet another indication of the direction they will be taking in regard to interest rates. If interest rates continue to rise, you’ve been thinking that now is the right time to consider selling your note, and you’d like more information about selling your note, contact Alvernia Capital Management and a representative will be happy to discuss your situation further.