When a homeowner contemplates the refinancing of a mortgage, the critical calculation is whether the lower interest rate being offered will produce a net savings fast enough to justify the cost of obtaining the new loan.
And while that same consideration applies when a co-op corporation is refinancing the mortgage on its building, other factors often come into play.
Among them are whether the existing mortgage carries a prepayment penalty and, if so, whether there is anything that can be done to avoid or minimize.
“There are three basic reasons for a co-op corporation to refinance,” said William J. Rank, a certified public accountant in Purchase, NY, who specializes in co-ops and condominiums.
“One would be to get a better rate and the second would be to borrow more money, and the third would be because the current mortgage is nearing the end of his mandate.”
Mr Rank said that when a co-op is created, the co-op company becomes the owner of the building. And in most cases, he said, is a mortgage to pay for the purchase.
This called a mortgage æ æ underlying mortgage is that a specific amount of money lent over a specific period of time, with interest.
In most cases, however, co-ops’ underlying mortgages are not like 15 - 20 - or 30 years’ free amortize “residential mortgages, which are fully paid at the end of the term.
Instead, Mr Rank said, many cooperatives to draw 10-year interest-only mortgages, in which the entire amount borrowed is still due at the end of the term.
Other co-ops, he said, have a “balloon” mortgage, ie, while the mortgage repayment schedule may be based on, say, 30-year repayment schedule, the unpaid balance of the mortgage is “due and payable “in, say, 10 years.
“And that balloon payment usually has to be refinanced,” Rank said, adding that when this is done, which advises clients to take a certain self-amortizing mortgage rate that does not have a balloon payment at the end.
In fact, if a co-op is refinancing because the term of the mortgage is about to expire æ or because it needs funds for repairs or capital improvements æ the co-op is pretty jammed with the best solution for the business that can arrive at the time it needs the money.
And while the terms may be good now, may not be as great a year from now.
In cases where the main reason for the refinancing is that current interest rates are favorable, seems to be the co-op is in a better bargaining position. After all, one might assume, the co-op can simply negotiate a new pact with its current lender or find a more reasonable source of funding.
But that assumption may not always be correct.
“Everybody likes to refinance when rates have fallen,” said Jerome L. Liebowitz, a co-op lawyer in Fort Lee, NJ “But banks are not stupid.”
Mr. Liebowitz explained that most co-op underlying mortgages contain what is known as a prepayment penalty, which penalizes the borrower if the loan is worth before the expiry of its mandate. Traditionally, the Lord said Liebowitz, prepayment penalties were calculated as a percentage of the outstanding balance of the mortgage imposed on a declining scale.
In other words, if a child 10 years of mortgage was refinanced with, say, five years remaining on the original deadline, there would be a prepayment penalty of 5 percent of the loan balance.
If the refinancing occurred with four years to go, the prepayment penalty would be 4 per cent, three years would be 3 percent, and so on.
Using this formula, it is quite easy for a co-op to determine whether it makes sense to refinance the amount of the prepayment penalty æ set in a predetermined percentage æ simply becomes an additional cost of refinancing. If the difference in interest rates is large enough, a refinancing may make sense even with the prepayment penalty.
In the early 1990’s, however, co-op lenders changed their strategy. Rather than impose prepayment penalties based on a percentage of the outstanding balance, the lenders instead started writing “yield maintenance penalties” on their mortgages.
“That basically means that if you want to prepay the loan, you will have to pay the lender what they lost as a result of the prepayment,” said Liebowitz.
In other words, no matter how much lower the interest rate that prevails is that the interest rate on the mortgage, the yield maintenance penalty provision assures the lender of being paid every penny that have earned for the entire term of the mortgage Even if the mortgage is paid off early.
“The formula for maintaining performance is extremely rigid,” he said. “In some cases, the penalty can be more than $ 1 million.”
In fact, the lowest interest rates below the rate charged to the mortgage, the greater the yield maintenance penalty will be.
Michael J. Wolfe, president of Midboro Management, a management company in Manhattan, said that if an existing 10-year-mortgage interest with only 8 per cent interest rates one years left, the yield maintenance penalty provision would allow the lender to determine how much to lose if the loan is paid off early. Normally, he said, the lender determines how much you can earn in the balance of the loan for the remainder of the number of years of investment in U.S. Treasury bonds.
From a year Treasury bonds that currently pays 2.41 percent, the lender would be allowed to penalize the borrower for the difference of 5.59 percent. In a $ 5 million outstanding balance, which would amount to $ 279500.
“We call it ‘the death of prepaid,’” said Mr Wolfe. He added that while the yield maintenance penalty provision can negotiate something at the beginning of the loan, such negotiation normally results in a higher interest rate.
Mr Wolfe said that yield maintenance premiums would be very frustrating for borrowers if all refinancings involved nothing but save a little money for loans at lower interest rate to pay the money owed since. But sanctions are truly painful when interest rates are so low that significant amounts can be saved by refinancing.
And they become unbearable when the reason for a refinancing is not just to refinance the mortgage, but to raise funds needed for repairs or capital improvements in the building.
“If today the rate is 6.5 percent and you have a year left to go to its current 8 percent mortgage, do you really want to throw the dice and wait?” Mr Wolfe said.
“If you prepay now, the prepayment penalty could be enormous. But if you wait a year, interest rates could be back until 8 percent.”
As is clear, however, there may be some room for manoeuvre for borrowers. “There is a very interesting solution to this dilemma,” said Gregg Winter, president of Winter & Company Commercial Finance Real Estate, a Manhattan mortgage broker.
Mr Winter said that in a number of recent transactions, has been able to achieve a “forward engagement and early rate lock” for customers may have to wait until one year before they can refinance their mortgages without paying a penalty.
“We’re working with a building which has now been locked in a rate of 6.87 percent to a new 10-year fixed rate loan,” said Winter. “And we have a proper articulation timed with the expiration of their current mortgage.”
There is a price to be paid, however, to be able to block a low current rate for several months. Overall, Mr Winter said, that price translates into an increase in interest rates two or three “basic points” for each month of rate lock. A basis point, he explained, is one-hundredth of a percentage point.
This means that if a rate is locked for 12 months, the borrower will pay an additional 24 to 36 basis points in interest æ or about one-fourth to one third of a percentage point more.
In other words, if the current interest rate is 6.5 percent, a borrower with a one-year period with interest the commitment and early rate lock will end up paying 6.75 to 6.83 percent in the mortgage when it takes a year from now.
“In most cases, the borrower has to send a good faith deposit of 2 to 3 percent of the loan amount,” said Winter. “If the borrower away from the operation, the deposit is lost. If he takes it, the money will be refunded when the loan closes.”
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