Q: What incentive can the holder of a five-year note on a house, with a below-market rate, offer the borrower to refinance before the note comes due? We hold a sizable note on a house in the District of Columbia, at 11 1/2 percent interest rate, which has three more years to run. We would like to take advantage of the real estate market, but do not know how to free up these funds. Can you advise?

A: Creative financing has put a lot of us in this very same situation. We sold property a couple of years ago when interest rates were high, and the only way to make that sale was to take back some financing for a period of time. Often, these notes ran for periods of two to five years.

To induce the potential buyer to make the purchase, we gave back financing at lower than market rates. Unfortunately, the interest rate situation has not stabilized and there is very little incentive for the present note holder to refinance at 15 to 17 percent when they still have three years to go on your 11 1/2 percent rate.

There are a number of options available to you, which should be explored. Let us look at these alternatives.

The most traditional method to have the note paid off early is to discount it. This means you will offer to accept less than the face amount of the note on the condition that your buyer is interested in the saving. However, if your buyer has to borrow that money at 15 to 17 percent, plus points that will probably have to be paid to the new lender, the discount may have to be substantial. For example, if you have an outstanding $100,000 loan, and your buyer is prepared to pay you $75,000 now, you would be taking a $25,000 loss.

But is that really a loss? If you have investment possibilities now, using today's dollars, and can purchase a good piece of investment property where you get both appreciation and the new tax depreciation benefit, it may very well be that the $25,000 loss will be made up quite rapidly. You have to sit down with your pencil and paper and "do the numbers."

Another possibility is to work out an arrangement whereby your borrower goes to a savings and loan association or a mortgage banker, and borrows the necessary funds at the current interest rate. You can agree to "buy down" the rate for the remaining three-year period, so that the buyer gets the equivalent of the mortgage rate he or she currently has with you.

For example, if the current loan is at 11 1/2 percent and a new loan in the same amount would be at 15 1/2 percent, the monthly figures look as follows:

$100,000 at 15 1/2 percent: $1,304.52

$100,000 at 11 1/2 percent: $990.30

Difference per month: $314.22

$314.22 times 12 months times three years equals $11,311.92

Thus, you would need a total of $11,311.92 to "buy down" the mortgage for the three-year remaining period. Additionally, if there are two points for the loan, that would be an additional $2,000. Thus, for a total of $13,311, you might be able to persuade your buyer to refinance for $100,000, which would give you $86,689 now to use as you see fit. Additionally, the buy-down dollars could be placed in an interest-bearing account, with interest accruing to your benefit, so that you will at least receive additional dollars over the three-year period. This should be reviewed carefully, but it is an option that your borrower may want to consider.

A third possibility is to take the note to your bank and pledge it for a new loan. You may find that your bank will be willing to give you a slightly better interest rate if they have the security of your note and deed of trust. Many banks are willing to discuss this pledge arrangement, and you should call your loan officer for additional details.

Selling your note in the open market is a fourth possibility, but the discount required for such an arrangement would probably not be acceptable to you. Obviously, if you are in real need of the money, you may want to take the discounted funds today--rather than wait for the note to mature three years from now.

We are all suffering from the lure of creative financing. Hopefully, this will be a lesson to sellers in the future.