When interest rates rise, the price buyers will pay for an existing note generally falls. Your payments are fixed, so a buyer who can now earn more elsewhere can only get a higher return from your note by paying less for it.
Why a fixed note loses value when rates go up
Your note was written at one rate and stays there, and the payer sends the same amount every month whatever happens in the wider economy. A note buyer, though, has choices about where to put money, and prices your note by yield, the return earned on what they pay. When safer investments pay more and the buyer’s own borrowing costs more, the yield asked of a private note moves up with them. With the payments unchanged, the price has to come down to deliver it. When rates fall, the same logic lifts the price.
Which notes feel it most
| Feature of the note | Effect of rising rates | Why |
|---|---|---|
| Many years left | Larger | The higher yield is applied to every payment, and distant payments are discounted hardest. |
| Few years left | Smaller | The buyer gets their money back sooner, so there is less time for the yield to bite. |
| Low rate on the note | Larger | The gap between the note’s rate and the buyer’s yield widens. |
| High rate on the note | Smaller | The note still pays close to what a buyer wants. |
Directions only, with everything else about the note held the same.
A note written years ago at a low rate with a long term still to run is the most exposed, because the interest rate on the note and the remaining term are both working against its value at once.
The effect on one note
Take a note that pays $1,140 a month at 6%, with 168 payments left and about $129,400 still owed. A buyer who wants an 8% yield pays $115,000 for it.
Illustrative example. It shows one buyer’s yield on one note.
Had that buyer’s target been above 8%, the price would have come in below $115,000, and with a target below 8% it would have been higher, with the note, the payer and the property exactly as they were. That follows from the way note buyers calculate a price: the payments are fixed, so the yield is the only part left to move.
Payoffs and property values
Higher rates make an early payoff less likely. A payer whose rate is below what banks now charge has little reason to refinance, so the note is more likely to run its full term. That matters if you were counting on a payoff, and to a buyer it means a longer wait for their money.
Property values can soften as well, because higher borrowing costs can slow home sales in some markets. The property is the security behind your note, so a buyer’s view of its value feeds into the price. This varies a great deal by area, and it should be settled by a current valuation and never by assumption.
What you control
Market rates are outside anyone’s control, and nobody can tell you where they will be next year. Waiting for them to fall is a bet. You keep collecting payments while you wait, which is no bad thing, but the balance you could sell gets smaller and the risk stays with you.
The part of the yield that reflects risk is yours to influence. A clean payment record, complete documents, paid-up taxes and insurance, and good equity count toward what your note is worth in any rate environment. Rates set the floor for a buyer’s yield, and the quality of your note decides how far above the floor they go.
Buyers do not all adjust at the same pace when rates move, so the yield can sit further apart from one buyer to the next than it would in a steady market. When you have your note priced, ask what yield each offer was priced at and compare the yields before the prices.
Selling fewer payments when yields are high
In a partial purchase you sell a set number of the nearest payments and keep the rest. Near payments are the ones least affected by a change in yield, because the buyer waits the shortest time for them. You raise the cash you need at a smaller cost and keep the distant payments, which you collect in full by waiting.
Whether a buyer will take a partial depends on the note, mainly on the payments left and the equity behind them. If one will, ask for a full-sale price and a partial price together, so you can see how much of the discount comes from the distant payments.
Related questions
Should I wait for rates to fall before I sell my note?
Nobody can tell you when or whether they will. Waiting means you keep collecting payments, but you also keep the risk, and the balance you could sell gets smaller. Base the decision on your need for cash, not on a forecast.
Does a rate change alter what my payer owes me?
No. The rate, the payment and the balance on your note stay exactly as written. Only the price a buyer would pay for those payments changes.
Do falling rates raise the value of my note?
Generally yes, because buyers will accept a lower yield. Falling rates also make it more likely your payer refinances and pays you off in full, which ends the note at its balance with no discount.