If you’ve studied seller financing or have a mortgage note that you’re ready to sell, then you’ve probably already come across the terms “face rate” and “discount.” Let’s do a quick overview of these two important terms.

What is the Face Rate of a Note?

The “face rate” is the interest rate being charged to the borrower as specified on the promissory note. This value is typically expressed as a percentage, and included along with the other note terms such as the amount borrowed and the length of the loan.

What is the “ideal” face rate on a note? Well, that depends on which party you ask. If you’re the buyer/borrower, then a lower face rate is desirable. Sellers generally prefer higher face rates when selling a property on seller-financing. Likewise, investors prefer higher face rates when purchasing existing notes.

A higher face rate becomes especially important when selling the note to an investor. Why? Because the higher the face rate, the more an investor will be able to pay for a note and still meet their yield requirements. In other words, the “discount” will be lower.

What is a Discount on a Note?

The “discount” is the difference between the face value (unpaid balance) of the note and the price the investor is willing to pay for the note, expressed as a percentage of face value.

Crystal clear? Maybe not. Let’s look an example.

Consider a note owner offering for sale a note with a face rate of 8 percent.

The investor, in this example, requires a yield of 12 percent on their note investments.

It’s this disparity between the note’s face rate and the investor’s desired yield that leads to the discount. Since the terms of the note are fixed (face rate, payment amount, etc.), the only option the investor has to achieve their 12 percent return is to pay less than the face value of the note.

Let’s add a few more numbers to our example. Assume the face value (balance) on the note is $50,000 and there are 120 monthly payments remaining. Using a financial calculator, we can determine that the payment amount at an 8 percent interest rate would be $606.64 per month.

If the investor were to pay 100 percent of the face value (par) for the note, then they would earn an 8 percent return (i.e., the face rate). In order to earn the desired 12 percent yield, the investor could only pay $42,283 for the note, which would represent a 15.43 percent discount (($50,000 – $42,283) / $50,000).

Be aware that this analysis is focused only on the impact of the face rate on the market value of a note. Other risk factors will also impact the investor’s offer in the real world.

Seller-Financing and Face Rates

The average face rate for marketable seller-financed notes ranges from 8 to 12 percent. While a high rate is ideal for profit from both interest payments and a potential future sale of the note, it’s also very important to take your state’s usury laws into account. Usury laws dictate the maximum legally allowable interest rate for various loans, including mortgages.

To summarize, when creating a seller-financed note, it’s important to realize that the face rate will have a significant impact on the profitability of the note. This is true as you hold the note and collect payments as well as when you decide to sell the note. If you’ve already created or purchased a note, just keep in mind that the face rate is etched in stone and will be considered by the investor when making their offer to buy the note.

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