Property owners sometimes focus almost exclusively on the interest rate and the period for which it is fixed when choosing a new commercial real estate property loan or multifamily loan. However , other factors have a significant impact on the “total cost of capital” and can restrict or expand owner options down the road. Before signing on the dotted line, be sure you have answered these nine questions.
1 . What are your plans for the property as well as your objectives in refinancing?
Choosing one of the most advantageous financing solution for your house or commercial property involves evaluating tradeoffs between the terms and conditions of alternative loan options. Making sound choices begins with a clear understanding or your plans for the property and objectives in refinancing. Is it probably that the property will be sold in the future and if so when? Are you reliant on income generated from the property at this point or are you looking to maximize income through the property in the future, perhaps after pension? Is there deferred maintenance that needs to be tackled now or in the near future? Is redesigning or other major upgrades or repairs expected in the next 5 to 10 years? Will you need to access the collateral in your property for other investments, for example , to purchase another property?
second . What happens after the fixed period?
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A few commercial property or multifamily financial loans become due and payable at the end of the fixed period and others. They are often called “hybrid” loans and they convert to variable rate loans following the fixed period. A commercial real-estate loan or multifamily loan that becomes due after the 5, seven or 10 year fixed time period may force refinancing at an unfavorable time. Financial markets may be in a way that refinancing options are expensive or unavailable. Or local market conditions might have resulted in increased vacancies or reduced rents, making your property less appealing to lenders. Frequently the lowest interest rate offers are for loans that become due at the end of the fixed time period and include more restrictive pre-payment penalties (see question #4). Hybrid financial loans convert to an adjustable rate loan with the new rate being based on a spread over either LIBOR or the prime rate and modifying every 6 months.
3. What is the term of the loan and the amortization time period?
The term of the loan refers to when the loan becomes due and payable. The amortization period refers to the period of time over which the principal payments are usually amortized for the purpose of computing the monthly payment. The longer the amortization period the lower the monthly payment will be, other things being equal. For apartment or multifamily properties, 30 season amortizations are generally available. For commercial properties, 30 year amortizations are more difficult to come by, with many lenders going no longer than 25 years. A loan using a 30 year amortization may have a lower payment than a loan with a twenty five year amortization even if it has a slightly higher interest rate. In most cases the phrase of the loan is shorter compared to amortization period. For example , the loan may be due and payable in ten years, but amortized over 25 years.
4. If loan converts to some variable rate after the fixed period, how is the variable rate motivated?
The variable rate is determined based on a spread or margin over an index rate. The index rate is generally the six-month LIBOR or, less often , the prime rate. The interest rate is computed by adding the spread to the index rate. The particular spread varies but is generally between 2 . 5% and a few. 5%. The rate adjustment most often occurs every 6 months until the loan turns into due. There is generally a cap on how much the rate can move at an adjustment point. However , a few lenders have no cap on the initial adjustment. This leaves the owner open to a large payment increase if rates have moved significantly.
5. What are the prepayment penalties?
Almost all fixed price commercial property loans and residence loans contain some form of pre-payment penalty, meaning there is an additional cost for you if you pay off the loan early, which may occur if you want to refinance or perhaps you are selling the property or if you want to create payments greater than the scheduled monthly obligations. Prepayment penalties generally take the form of a set prepayment schedule, a yield maintenance agreement or, defeasance. A collection prepayment schedule predetermines the penalty expressed as a percentage of the mortgage balance at payoff and diminishes as the loan ages. For example , the particular prepayment schedule for a 5 12 months fixed loan might be quoted because “4, 3, 2, 1” meaning the penalty to pay off the mortgage is 4% of the balance in year 1, 3% in season 2, etc . A yield servicing agreement requires a penalty computed utilizing a formula designed to compensate the lender for your lost interest revenue for the outstanding term of the loan over a free of risk rate and discounted to a present value. The formula can be complicated, but the result is almost always a more punitive penalty than a set prepayment schedule and will generally make earlier pay-off financially unviable. The third type of penalty, defeasance, is used less frequently. It works like a yield maintenance agreement in that its intent is to keep the lender whole for the lost curiosity revenue but it accomplishes that simply by requiring the borrower to replace other securities that would replace the lost revenue instead of making cash payment. Often the most attractive interest rates offered are associated with loans along with either a yield maintenance agreement or defeasance. There is generally a window starting 180 to 90 days prior to the loan is due when the penalty expires to allow time to arrange refinancing. These types of loans generally become due at the end of the fixed period.
6. What are all the fees and charges associated with closing the new loan?
Refinancing could be costly and knowing all the costs is essential to evaluating if refinancing is the right choice. The biggest costs are for appraisals, title insurance policy, escrow fees, environmental review, points, and processing and/or loan fees. Appraisal fees will run $2, 000 and up. Phase I Environment Assessment cost $1, 000 or more. Processing and/or loan fees charged by the lender begin about $1, 500 and rise from there. Factors may or may not be charged by the lender. Several lenders, particularly on apartment or multifamily loans, will cap the particular expenses at $2, 500 to $3, 000, excluding title plus escrow. It is important understand the total expenses in comparison to the monthly savings indebted service resulting from refinancing. How many a few months will it take to recoup the costs associated with refinancing?