Commercial Loan Refinance

We are often are asked when is the optimal time to refinance a commercial loan.  Many factors such as market interest rates, prepayment penalties, existing loan terms and the overall goals of the borrower come into play.  There are no set answers, but below are some real world thoughts on how you might analyze your own commercial loan refinance.  

Traditionally, the analysis to keep an existing loan in place or to refinance into a new commercial loan can become very complex.  Financial advisors like to use the Discounted Cash Flow method which essentially compares the two loans on the Net Present Value basis. We have found though, that most commercial building owners are primarily interested in how the proposed refinance will:

1. Effect their monthly cash flow.
2. What the closing costs will be and how these costs will affect their equity.
3. What the out of pockets costs will be.
4. How long will it take for the monthly savings of the new loan to "pay back" the owners closing costs.

Principal pay down is obviously another important component of any commercial loan.  However, for most owners, especially those with highly leveraged properties, cash flow is more pressing.  This is due to the relative high debt payment versus net cash, after all the expenses have been paid.    

Example 1.  Owner Occupied Office Building

Borrower is 3 years into a 5 year fixed, 20 year amortized loan and is considering refinancing into a 30 year fixed, 30 year amortization commercial loan.  The borrowers primary motivation is a desire to increase cash flow(monthly savings to help businesses overall profitability.  In addition, the borrower is concerned over future rate increases when the existing loan balloons in 2 years.

Increase in cash flow is $1,835 (savings) per month or $22,028 annual.  Essentially, from a cash flow perspective, the borrower would recoup the costs of the loan in less than one year, despite the rate increase by 75 basis points.  Although the borrower would have to pay for the appraisal and environmental report upfront, they would be “refunded” and rolled into the loan amount if desired.      

In our experience most business owners would be very interested in pursuing the proposed refinance.

Example 2.  Investment Property, 10 Unit Retail Center  

Borrower has owned the property for 7 years and has two loans on the subject property.  First loan is a conventional floating rate loan that adjusts annually, amortized over 25 years and the second is seller held.   It is amortized over 20 years and has a fixed 20 year rate.  Neither loan has a balloon provision; however the first loan does have a prepayment penalty of 5% of the remaining loan balance, which is in effect for 3 more years.      

Cash flow increase is $2,704 per month or $32,449 per year while the cost to close the loan is high at $83,500, due primarily to the prepayment penalty.  The borrower is facing a closing cost payback period of over two and a half years.  In addition, the interest rate has gone up considerably on the proposed loan, which of course increases the overall long term cost of the loan. 

Not an easy decision for the borrower to go forward with the commercial loan refinance.   The option to go forward would probably rest heavily on the borrower’s opinion of where the future interest rates will be when the prepayment period ends.    

It is interesting to note that the borrower would be able to increase his loan amount to $2,333,964 (cash out proceeds would be approximately $598,000) if he choose to.  This is due to the increase in cash flow.  The building Debt Coverage Ratio is at a 1.54 on the proposed loan; the typical minimum Debt Coverage Ratio is 1.2.   If the borrowers intent was to pull cash out of the property to inject into another property (or for any other reason) this would probably be a much easier decision to go forward with the loan.

Get real answers now to your commercial loan refinance.  We would be happy to provide quotes and Pre Approve your loan now.  Please take a moment to provide your information. Or call 248 990 7602.