How To Set Up Your Real Estate Contract For Maximum Safety and Value

Part 4 – Interest Rate

Setting the terms of the contract … the interest rate, the length of the loan, the payment amount, etc. should reflect the risk you are taking, but it also has to reflect reality. For example, if you could always set the interest rate on the contract at 18%, your risk would probably be covered. You would also have a difficult time finding a buyer, even a “nothing down bad credit” buyer who would be willing to pay that much interest.

What you are willing to accept depends on how motivated you are to sell, among other things. The first thing you should know is that, from the standpoint of value, interest rate is THE most important factor on your contract. As a guide, it's reasonable to set the minimum interest rate above whatever the current norm is for conventional lending. You can run an internet search with the keywords "what are conventional mortgage rates today" to get a good idea what the going rate is. A popular saying in real estate is to set the interest on a real estate contract to 1% above the going rate. It makes sense to use this as a starting point and go higher from there. In the world of owner financing, the starting point is about the only "rule" there is. Consider, however, the risk and affordability factors mentioned in previous articles and go as high as you can and still maintain affordability. Keep in mind that if you ever need to sell your contract for cash, the interest rate is the most influential factor in determining the cash value of your contract. The higher the interest rate, the higher the cash value! Remember also that if a buyer wants low rates, they must be able to qualify for a conventional loan. Compared to conventional loans, owner financing is about twice as risky. It follows that owner carry back loans such as the one you are considering should bear interest rates considerably higher than what a lender would charge. Conventional lenders screen out and turn down the riskiest buyers, and they won’t lend on many types of property. It is very likely that the transaction you are thinking about owner financing is one of the deals that a conventional lender would turn down. If a conventional lender would not do the deal at all, why would you lend money to the purchaser at an interest rate that is close to what the lender might do … if they would make the loan in the first place? Get the highest interest rate you can negotiate … you are taking a bigger risk than you might think.

If you are owner financing because of the income and interest rate, please read the article “Harnessing the Financial Power of Your New Mexico Real Estate Contract”. (See the Newsletter Section of the Web Site) That will further motivate you to set the interest rate at a level that is in line with the “market”.

The next article in this series will cover other issues that deal with safety and value. Included will be techniques you can use when you can’t set the interest rate high enough to cover your risk, setting terms that will help you control buyers who are not paying as expected, and a few other time tested and helpful hints.