I own a rental property which is currently under partial renovation. The building has a commercial tenant on the ground floor, which gives us (myself and my partners) enough income to cover our current mortgange. We are now renovating two apartments on the upper floors, and have an offer to refinance our higher rate commercial loan. The loan is a combination constructionloan and mortgage. It gives us part of the loan to complete construction in the next 4 months and then the remainder to pay off the existing loan after construction is completed. The loan is for $390,000, 30 year, has a rate of prime + 1.25%, that converts to a fixed rate when construction is completed, and has a 1% origination fee. The building has been appraised for $820,00 after construction is completed.

My concern is that this new loan requires us to have a pre-payment penalty of 5/4/3/2/1, which resets each five years for the life of the loan.

As the loan officer explained to us, they require this for their annual financial planning, etc. It seems to me this is an excuse to try and get some more money out of the deal, and limits when we can refinance or sell the building in the future, without a major added expense. We are under a tight schedule and don't want to lose this offer, but my feeling is this is not worth compromising.

This is our first project and we are generally unfamiliar with commercial lending practices. I would appreciate your thoughts on this.

Thanks.

John

John:

Let me see if I can address your situation…

The loan is for $390,000, 30 year, has a rate of prime + 1.25%, that converts to a fixed rate when construction is completed, and has a 1% origination fee.
All of that seems pretty standard. The rate is competitive at 5.25% {current prime + 125 bps}. The origination at 1% is within the normal, although it could be negotiated a bit down to $2,500 or $2,000 {not sure if they will accept, but you can try}. The thirty-year maturity is a bit out of the ordinary. Is it possible that you misunderstood and what resets every five years is the rate and not the prepayment penalty?

The building has been appraised for $820,00? after construction is completed. This is great, but do you have an “as-is” appraisal? The reason why I am asking is that you need $390,000 to refinance the mortgage and pay for improvements {if I read your post right}. Then if your property is worth at least $520,000 “as is”, you could qualify for a straight out refinance.

My concern is that this new loan requires us to have a pre-payment penalty of 5/4/3/2/1 I would be concerned about that too…. not too concerned if you are really thinking of holding to the property for five-years, but why take on this problem. What if there is a falling out between the partners and you need to sell? What if someone comes around in 3 months and offers you a million bucks for the building. 5% X $390,000 = $19,500 that is a good chunk of change. If anything try to negotiate this too.

, which resets each five years for the life of the loan…. As the loan officer explained to us, they require this for their annual financial planning,
This is why I think that the lender was talking about interest rate resetting. The bank does the repricing in order to safeguard against interest rate risk. This is normal. However, resetting a prepayment penalty is not normal.

My advice: Talk to the lender about:

1- Making sure that what resets is the interest rate and not the prepayment penalty.
2- Try to negotiate the origination fee down.
3- Try to negotiate yourself out of the prepayment penalty.

Depending on what you can get or can not get, then you could do more work such as:

1- Get a copy of the appraisal.
2- Talk to another lender about giving you a loan under similar circumstances, but with a lower origination fee and no prepayment penalty.

Hope this helps

It just ocurred to me that if you can't get the prepayment penalty out, try to negotiate better terms such as 3/2/1 instead of 5/4/3/2/1.

It comes down to negotiating skills, try to first reduce the origination and lets say you get it down to $2,500. Then you can say something like:

"I am also concerned about this prepayment penalty, if I have to sell the building within the next year, not only am I giving you $2,500 to get the loan, but have to pay you almost $20,000 to get out? It just doesn't seem right after all in this case the money will be out for less than a year and you would be making over 10% on it. Can we take that out?"

if that doesn't work, try for the 3/2/1

Good luck