A seller financed a comparable sale by carrying back a note at a stated interest rate well below the market rate for similar notes at the time of sale. How should the appraiser treat this sale price to reach a cash-equivalent indication?
Correct Answer
D) Adjust it downward, because the note is worth less than its face amount
When a note's stated rate is below the market rate, the seller is presumed to have raised the price to make up for the cheap financing, so the note is discounted to its cash-equivalent value and the price is adjusted downward. An upward adjustment applies only when the note's rate is above market. Leaving the price unchanged ignores the non-market financing, and deducting the full face amount treats a note with real value as worthless.
Why This Is the Correct Answer
Option D is correct because a note carrying a below-market rate is worth less than its face amount, and the seller is presumed to have raised the price to compensate. Discounting the note to its cash-equivalent amount lowers the indicated price toward market value.
Why the Other Options Are Wrong
Option A: Adjust it upward, because the note is worth more than its face amount
Option A adjusts upward on the view that the note is worth more than face. That fits a note with an above-market rate; a below-market note is worth less than face, so the adjustment is downward.
Option B: Leave it unchanged, because the buyer agreed to pay the full stated price
Option B leaves the price unchanged because the buyer agreed to the full stated price. The stated price includes the benefit of cheap financing, so it overstates the cash-equivalent value of the property.
Option C: Deduct the full face amount of the note, because the seller received no cash for it
Option C deducts the whole face amount of the note as if the seller got nothing for it. The note has real value, only less than face, so only the discount from face is removed.
Cheap loan, pricey house
A below-market note means the buyer paid with cheap money, so the price was pushed up. Discount the note and the price comes back down.
How to use: Use this to set the direction of any adjustment for a seller carryback or assumed loan at a non-market rate.
Exam Tip
Compare the note's rate with the market rate first: below market means a downward adjustment, above market means an upward one.
Common Mistakes to Avoid
- -Reversing the direction for below-market financing
- -Treating the stated price as cash equivalent when a non-market note is involved
- -Deducting the note's entire face amount
Concept Deep Dive
Analysis
This question tests the direction of a cash-equivalence adjustment for below-market seller financing. A note paying less than the market rate is worth less than its face amount to an investor. Because the seller likely raised the price to offset the cheap financing, the note is discounted and the price comes down.
Background Knowledge
Market value is stated in cash or comparable financial terms. When a seller accepts a note with non-market terms, the appraiser converts the note to its cash-equivalent value, often by discounting its payments at the market rate or by comparing sales with and without such financing. The direction depends on whether the note's rate is below or above the market rate.
Real-World Application
A rural comparable sold with the seller carrying a note at a rate well under current bank rates. The appraiser discounts the note's payments at the market rate, finds the note is worth less than its face, and lowers the comparable's indicated price by that difference.
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