Do your homework before refinancing a commercial mortgage
Things to consider when refinancing a commercial mortgage
- Weigh the costs against the benefits before opting to refinance a commercial mortgage.
- Refinancing can help lower interest rates, avoid balloon payments or provide needed cash.
- Know the fees for refinancing, as well as if there's a prepayment penalty on the original loan.
- Run the numbers to see if the savings outweigh the costs.
- It's wise to shop around, since interest rates vary.
A long-running climate of low interest rates has made mortgage-refinancing attractive for many homeowners. But refinancing is trickier for commercial mortgage borrowers.
Often it's worthwhile, but it can be a very costly process, and interest rates aren't necessarily the main factor that determines whether refinancing makes business sense. If you're considering such a move, it pays to know exactly what you can achieve through refinancing by carefully running the numbers to compare both the savings and the costs.
Benefits of refinancing
1. Get cash. Refinancing lets you cash-out if you have substantial equity in your property. Refinancing a loan gives you flexibility in gaining access to your equity. You can establish a line of credit to be used when you need the money, for instance, or collect a lump sum. It also affords you options on how to spend the money. The cash can, among other things, become working capital to pay day-to-day operating expenses, or it can be used to finance property improvements and repairs. But cashing out has tax implications, especially if you eventually sell the property, so it's a good idea to consult a tax professional.
2. Balloon avoidance. Massive balloon payments that come due at the end of the term of the original loan can be paid off with a refinanced mortgage. Often, refinancing is the only way borrowers can make that last payment, and they go into the original loan knowing that refinancing will be essential, regardless of the new interest rate.
3. Lower rates. Lower interest rates are welcome, of course, and are part of refinancing deals for those who qualify. Perhaps your formerly fledgling business is stable enough for a less-costly (and longer-term) mortgage, or maybe rates in general have dropped since you obtained the original loan. In any case, lower interest rates translate into more money in your pocket to pay for nonmortgage business expenses.
4. Fixed-rate loan. Steady, fixed payments can be part of the refinance package. Adjustable-rate commercial mortgages make sense when interest rates are stable or dropping, but they become a drag on the business when the cost of credit increases. A fixed-rate loan can remedy that, as well as make financing more predictable and give you a better handle on long-term cost and cash-flow projections.
For the borrower, the question is whether the benefits of refinancing are greater than the cost of obtaining the loan.
And the costs can be significant: Commercial Loan Direct, an online commercial mortgage banker, says borrowers should expect to pay up to $10,000 in fees for appraisals, environmental reports, processing and title fees, among other charges. All of that comes before the lender's refinance fee, which typically amounts to 1 percent of the loan.
Some of those costs can be rolled into the loan package, but borrowers should be prepared to pay at least $5,000 up front for the appraisal and environmental report. Also, all or most of those costs are deductible as business expenses.
Another potential cost is prepayment penalties. Many commercial mortgages have them, and they can be substantial. Check your original loan and factor in any penalties when you're deciding whether to refinance.
From there, borrowers can use common commercial mortgage calculators to arrive at costs and benefits. For example, in the case of a $1 million loan financed over 20 years, every percentage point drop in the interest rate will cut the mortgage payment by about $500 a month, or $6,000 a year. Assuming $20,000 in refinancing costs and fees and no prepayment penalty, a quick calculation shows that refinancing into a loan that offers a 1 percent lower rate will allow you to recoup the costs in a little more than three years.
It's a different story if you're facing a balloon payment. There's a good chance your monthly payments will increase when the loan is refinanced, assuming you've been paying interest-only until the balloon payment comes due. Still, the refinancing can be a significant benefit as a source of long-term loan stability.
As with any loan, shop around, because interest rates and fees vary. Also, gather up the required paperwork early in the process. Depending on what you're refinancing, you'll need records of leases, tenant rolls, personal-income statements, current loan documents and up to three years of profit and loss statements and tax records. Find out what the lender requires early in the process to avoid delays in the credit decision.