Do Rising Interest Rates Make Selling Your Note a Better Way to Secure the Cash You Need?
During the financial crisis of 2008, the Federal Reserve Bank (the Fed) lowered the federal funds rate. The prime rate – the interest rate banks use to set lending rates for consumers – fell to encourage banks to lend money and spark growth.
As the economy improved after 2008, the Fed gradually increased the federal funds rate to as much as 2.4%. (As of April 2020, the effective Federal funds rate is 0.05%.)
How Do Rising Rates Affect the Economy?
If the Fed raises rates again, it affects the whole economy. It will be more expensive to borrow and more beneficial to save. The most common effects of rising rates are:
- Credit cards and short-term loans charge higher rates since short-term borrowing is seen as riskier. There’s a higher chance that borrowers might default.
- Auto loans and other long-term borrowing rates may rise modestly.
- Mortgage rates are not affected much by rising interest rates. But if inflation rises, it will drive mortgage rates higher, so fewer people can afford to buy homes.
- Savings rates typically increase, because people earn a higher amount of interest on savings.
- Consumer spending drops because people are saving more.
What Do Rising Interest Rates Mean When You Own Mortgage Notes?
If you provided seller-backed financing on a home that you owned, you may have entered into that agreement in the last few years.
If your buyer chose seller-backed financing because their credit didn’t meet strict lending standards, you probably set an interest rate somewhat higher than bank rates, to make a decent return on your investment.
Over the last few years, interest rates on mortgages for buyers with excellent credit have ranged from about 3% to 4½%. On your seller-backed mortgage, you might be earning 6%, 7% or more in interest.
When interest rates rise, you may wonder what do higher rates mean for you? How might they affect your decision to release yourself from a seller-backed mortgage note?
Sellers Have 2 reasons to Move Away From a Seller-Backed Mortgage
- You face an unexpected need for a lump sum of money.
- You have a desire to invest in an investment that’s more liquid or offers a better rate of return.
We discuss both reasons below, in the context of potential impacts 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.
You could seek a personal loan, but it comes with downsides:
- You’re at the mercy of a bank in regard to how much you can borrow.
- You may be charged additional fees to borrow money.
- The paperwork and due diligence banks require cost you time and money.
Most important: as interest rates rise, it costs you more to borrow the money you need!
Think about it. Personal loans come with interest rates of 6% to 36%, according to bankrate.com.
If interest rates rise, so will these rates. A cash advance line from a credit card presents the same situation.
Let’s take an example. Say you’re earning 6% from your seller-backed mortgage. But you borrowed money from a bank or took an advance on a credit card. Now you’re paying much more in interest on your loan than you earn from your mortgage note – so you end up losing money.
Selling your note, or even part of your note, can provide you with the money you need now.
Mortgage notes are worth more when interest rates are lower. So you are likely to receive more money for your note now than if you wait until rates begin to rise.
Unlike bank borrowing, you can get the proceeds of a mortgage note sale fast. Most important, you save all the interest you’d pay if you borrowed – interest that only gets more and more expensive as rates rise.
Ask, Can a Different Investment Yield More Money for You?
When interest rates rise, rates on savings accounts, certificates of deposit (CD’s), and other similar savings vehicles also rise.
As of April 2020, the best savings rate is about 1.5%. The best certificate of deposit (CD) rate is about 1.7%.
The biggest advantage to putting your money into a savings accounts or stock investment is that they are more liquid assets. You might pay taxes on an early CD withdrawal, but you can access your money pretty quickly whenever you need it.
Suppose you want to use the money to invest in another real estate opportunity. Even though it lacks the liquidity of a savings account, it can provide more income than you make now.
If interest rates rise, and inflation rises too, mortgage rates will increase. You may be able to swap out your current note for another note that earns a higher rate. That means you could end up earning a better rate on a new real estate venture, putting more money in your pocket each month.
Alvernia offers you a simple, practical way to invest in real estate, based on best practices from top investors.
As your guide, we help you avoid the “trial and error” approach and the need to spend on specialized real estate education — so you free up more capital to invest.
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If you’re thinking that now is the time to consider selling your note, contact us for a free consultation.