How To Set Seller Note Interest Rates

To setting the interest rate on a seller financed RV Park note. Now, let me start off by saying that. We would typically prefer an RV part to be purchased using seller carry more than any other form of debt. We love seller financing. All of our early deals were seller financed. Why is that? Well, number one. Seller financing typically is the most stress-free. There's no application process, there's no credit scoring. If they like you, you're approved, and if they hate you, you're not.

But on top of that, you can normally get lower down payments, lower rates, non-recourse, which means they can't come back on you if for any reason you ever have a loss with it. You get to escape the entire world of banking, which is great, particularly right now in an America that's in such turmoil with banking. When you go a seller or carry, you're dealing not with a FDIC institution, but just a nice, benevolent mom and pop.

So we always want seller financing if we can get it. But there's a few wildcards that might stop you from using seller debt. One would be if you can't get along enough term. So if mom and pop say, Well, we'll carry the financing, but here's the deal, we'll only do it for two years or three years. Well that's not gonna do you any good.

You can't go back in the marketplace and try and get a loan two or three years into the future. You're better off just going out and getting a bank loan on the front end and getting a longer term. But another way things can derail is the interest rate on the loan.

So that's what we're going to focus on is how you figure out what the interest rate should be on that seller finance note. Well, the first thing we need to think about is where do we start? What is the benchmark for seller financing? On a bank loan, that gold standard is going to be the prime rate. Or the interest rate that's set by the federal government. And we've all watched Jerome Powell go crazy with that, right?

So since 2022, the Fed and Jerome Powell have gone nuts. They've raised rates faster than ever has been done in the last 40 years. So as a result, you have to figure out today where do things stand in line with the Fed. But in seller financing, it's different. Because it's not the federal funds rate that banks have to pay for the cost of getting money. Instead, it's how much mom and pop can get.

if they put that money into a CD or a treasury, because that's their go-to mechanism to invest. So when they're looking at carrying the paper, they have two options. They could carry the paper or they could have you pay them in cash. and then put that money in a C D. Because most moms and pops are extremely risk averse. They're not gonna gamble it in the stock market. They're not gonna buy cryptocurrency. No, they're gonna put it in good old standard CDs.

or treasuries, nice stable things that pay a dividend. So that's what they're after. So all you would need to do then from an interest rate perspective to be highly attractive is to match what they can get on a CD or a treasury, which right now is roughly four to five percent. So even though banks might be charging 7% right now or maybe more, you could probably get in the door with a mom and pop for two points lower simply because that's as good as they could get.

So that's the first thing to think about is where do I need to start? Well, you know you want to end up or you should not have to end up higher than CDs or Treasuries. So you should not be paying a seller note amount right now that's greater than probably five percent.

Now, another thing to think about though is that why don't we maybe make that rate Stair step up over time. Let's say you're buying an RV park in which there's there's a lot of work to do, a lot of cap packs, things are very much run down. Maybe you need to devote some of that monthly debt payment into making those improvements.

So maybe you say to mom and pop, look, the park's in bad repair, and that's fine, I'll go ahead and pay you the amount we agreed to. But I think what you'll need to do is on that note, let's start off in year one paying you one percent. And then in year two, two percent, and year three, three percent, and year four, four percent, and year five, five percent, and then every year they're after five percent.

That flexibility on the rate has now given you much greater cash flow to make those repairs. And sometimes mom and pops will agree to that. They'll say, okay, yeah, that that that sounds fine to me. Another item to think about is should the rate be variable as opposed to fixed? Because right now we are all assuming that Jerome Powell and the Fred are going to be reducing rates when the nation hits a recession, which most people peg as being in the year of 2024.

Now, if the rates collapse in 2024 and CDs and treasuries go down to 2% from currently five. then wouldn't you want to have your interest rate go down as well? This is something you would have to bank on. You'd have to think very hard and seriously about whether or not you believe rates are going to go

higher in the future, stay steady and flat in the future, or start to reduce. And if you say, well, I think they're going to reduce, then maybe you want to have the interest rate with mom and pop actually be variable as opposed to fixed. Also, it might be smart of you to somehow tie

the interest rate in that case to what the Fed rate is. Because the Fed rate may decline faster than that of the C D. If the Fed is starting off right now with mortgage rates as high as seven percent, it might have a faster decline. So once again, if you're gonna go with a variable rate structure, maybe you need to tie to whatever you bank on might decrease faster.

But now what happens if mom and pop, despite everything I just said, say, well, hey, I want bank interest rates. I called a bank and the bank told me if they financed, they were going to charge seven percent. Well, I'd still go with the seller carry deal at that rate. Because anytime you can get a seller finance note that approximates that of a bank,

It's a winner. Seller debt is always superior to bank debt. I've never seen a situation where someone can pick and choose between the two, with all the terms being identical, that would not prefer to go with the seller debt. So seller debt always ranks higher. So even if you can't get terms with the seller any more attractive than a bank, you would still go seller. Even if it was the same down payment and the same interest rate, because at least the seller's note is non-recourse.

And at least a seller's note is outside of the banking world. Remember we've seen a few bank failures earlier this year, and if you have a bank failure and a loan within the bank that fails, remember they have the right to pretty much call the notes. They may not say that, but if you read through all the fine print they pretty much do.

Moms and pops are free of any such obligations, so when you have a mom and pop note, it's completely safe all the way till the end of the movie. And perhaps a key takeaway from this is the concept of creativity.

Because you can't really be creative with a bank loan. It's kinda like the contract, you rent the car, it hurts. You don't have to sign it, but if you don't sign it, they won't rent you the car. You can't just say, Well, I don't like this paragraph or I want to add a sentence here or there. Banks have no creativity. But with moms and pops, you have that ability to make some things variable and to do things differently.

And to structure every deal is a one-time custom crafted, one of a kind object. So perhaps the interest rate could be variable. Perhaps it could stair-step. Perhaps it could be interest only in the early years. These are all things that you can do to make your deal work. And remember that the best way to buy an RV park is with a win win attitude where both parties are happy. And in some cases, the way you can get to the sales price that mom and pop desire is through the seller note.

Through creativity, through working around obstacles using interest rates, and that often helps you forge a deal that's superior to anything you could do with a bank. This is Frank Rolf of the RV Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon.