Interest Rate

The interest rate on a mortgage note is the annualized percentage applied to the outstanding principal balance to calculate the interest portion of each payment. It is one of the core economic terms defined in the promissory note and directly determines both the borrower's cost of borrowing and the note investor's contractual return on the debt. When buying notes in the secondary market, the interest rate on the existing note — combined with the purchase price — drives the investor's actual yield.

Fixed vs. Adjustable Rates

Residential mortgage notes carry one of two rate structures:

The vast majority of non-performing notes traded in the secondary market carry fixed rates, because most ARMs were originated during specific periods (2004–2007) and have either defaulted, been modified, or paid off.

Interest Rate vs. Investor Yield

The note's contractual interest rate is not the same as the investor's return. When a note is purchased at a discount to the unpaid principal balance, the investor's effective yield exceeds the stated rate. Conversely, buying at par or above par means the yield matches or falls below the contract rate.

For example, a note with a 6% interest rate and a $50,000 UPB purchased for $30,000 will produce a yield well above 6% if the borrower pays in full — because the investor paid only 60 cents on the dollar for the right to collect the full balance plus interest.

This spread between purchase price and contractual balance is the fundamental economics of note investing. The interest rate determines cash flow; the purchase discount determines profit.

Interest Rate in Loan Modifications

When restructuring a non-performing loan through a loan modification, the interest rate is one of the primary levers available to the investor. Reducing the rate lowers the borrower's monthly payment, which can make an unaffordable loan sustainable without requiring principal reduction.

Common modification approaches involving the interest rate:

• Rate reduction — Lowering the rate from the original contract rate to a level the borrower can afford, often 3–5% for re-performing modifications
• Step-rate modification — Starting at a below-market rate (e.g., 2%) and stepping up annually until reaching the target rate, giving the borrower time to adjust
• Rate freeze — Keeping the current rate but extending the loan term to reduce the payment amount

The modified interest rate directly affects the present value of the modified note and therefore its resale value if the investor decides to sell the re-performing note on the secondary market.

Default Rate

Many promissory notes include a default rate — a higher interest rate that takes effect when the borrower is in default. Default rates are typically 3–6 percentage points above the contract rate. While the default rate increases the total amount owed on paper, note investors should be realistic about collectability — a borrower who cannot make payments at 6% is unlikely to pay arrears calculated at 12%.