Like any relationship, the one between you and your commercial mortgage loan can be complicated. It may seem like the perfect pairing when you start, but doubts have a way of creeping in — especially when it comes to your long term plans. Before you commit, it only makes sense to envision that future and the price you will pay if you decide to part ways early.
What are prepayment penalties?
Like a prenuptial agreement for loans, many commercial loans come complete with a prepayment penalty. Similarly to most prenups, it’s designed to protect the party with the greatest upfront financial stake in the union, in this case the lender. When the lender calculates your loan terms, it is counting on the continued revenue from interest payments.
This is where its earnings come from. Investors who purchase mortgage backed securities also make similar calculations. If a loan payment stops early, in the case of a buy-out, the lender and investors stand to lose a lot of future earnings. The prepayment penalty is there to make up this gap or discourage an early exit all together.
How are prepayment penalties determined?
A prepayment penalty is usually a percentage of the remaining loan balance at the time of your last payment. The exact percentage varies depending on the loan terms and the lender.
Prepayment penalties can take several different forms, but the two most common types are yield maintenance and defeasance. When facing a yield maintenance penalty, the borrower pays the difference between the original loan interest rate and the current market rate for the rest of the loan’s term. Under a defeasance penalty, the borrower must offer a different form of collateral to make up the difference, like treasury bonds.
Does it make sense to prepay your loan?
In these times of seductively low interest rates, many borrowers are now considering leaving their commercial mortgage loans earlier than they had planned to refinance. In some cases, large balloon payments may be looming years down the road when banking rates will likely be higher. While it may seem like a no-brainer, here is where those prepayment penalties and their terms kick in. The question becomes, should you refinance now and pay the penalty or wait and hope that interest rates are still competitive when your loan comes due?
The short answer is, if you’re confident that interest rates will increase by the time the loan matures, it may make sense to pay the penalty and refinance now. On the other hand, if your business is currently struggling and capital is low, it could be safer to hold off on paying the extra expense and simply refinance at the regularly scheduled time.
Do you have prepayment penalty options?
When it comes to your commercial mortgage loan, it makes sense to picture the end even before you begin. Look for a partner that will allow you the flexibility to take advantage of opportunities that are right for you.
When you team with Commercial Direct, a division of Silver Hill Funding, LLC, you can design the kind of penalty plan you want included in your loan. The choice will then either increase or decrease your monthly payments. Best of all, there will be no surprises down the road. By visiting our loan customizer page you can see how Commercial Direct’s prepayment penalty options affect your rates now and in the future.
What’s the bottom line?
Early exits and the payment penalties that come with them are common in the world of small-balance commercial mortgages. Before you take out a loan, be sure to think ahead about your long-term intentions for both your property and your loan. Then, choose a lender that will allow you to select a penalty option that fits your needs — guaranteeing a happier, healthier and more profitable union.
For more information about prepayment penalties and other commercial mortgage topics, be sure to contact one of our experts at 1-844-346-2913 or [email protected].