Pay it Forward

The board members of Palmer Terrace in New Rochelle would not necessarily consider themselves betting men and women, but when interest rates began to dip two years ago, discussions heated up over how far rates would drop and whether the co-op should take the plunge and refinance. The up side was that getting a new mortgage with a much lower interest rate. The downside was paying a hefty penalty for prepaying the existing mortgage. The hedging went on for some time. But in the end, the refinancing crowd won over the "wait-and-see" crowd, and today all the shareholders are reaping the benefits: a savings of $60,000 in annual mortgage payments.

It was a gamble, because no one was sure what interest rates would do. But these days, there is an incentive for co-ops within six months of their loan's maturity to take immediate advantage of refinancing. Carefully structured agreements with lenders can allow buildings to lock in low interest rates and then delay signing a new loan for a period up to six months to avoid paying hefty prepayment penalties.

The agreements are known as forward commitments or early rate locks, and for the 87-unit Palmer Terrace, being able to lock in a low interest rate six months before its underlying mortgage expired was the tipping point in the board deciding to move early on refinancing their mortgage.

"Rates are still going down. In that sense, it wasn't the most perfect decision, but we still saved money," says Bill Brady, the co-op's president. On May 27, 2002, the building locked in a low interest rate of 6.66 percent on a new mortgage, but didn't close on the mortgage until November 1, 2002, saving the building $40,000 in prepayment penalties. Of the seven board members who approved the refinancing, there were a few holdouts, who kept warning that interest rates would continue to drop, remembers Brady. "If we had waited a little longer, we would have saved a little more, but I didn't know that. They were historically low rates and we didn't know in which direction they were going."

The ability to lock in a low interest rate and hold off on signing a new mortgage agreement is becoming increasingly more attractive these days as more cooperatives are looking for ways to hold the line on their budgets. "For budget purposes, co-ops love it," observes Raphael Fink, a partner in the Finance Group, which specializes in underlying mortgages. "If you tell a managing agent you can present a budget that will be balanced without a maintenance increase, they jump all over it."

But co-ops need to look before they leap, warns Edward Howe, senior vice president of the New York office of the National Cooperative Bank (NCB), which has been working with co-ops on forward commitment agreements.

There is one key factor that co-ops need to weigh before looking for a forward commitment agreement: how close is the current mortgage to its expiration date? Typically, co-ops will lock in a rate three to six months before the current mortgage expires. If co-ops want to lock into a rate longer than that, they will be paying a higher interest rate on the new loan, or they will be paying a higher fee to lock in the new rate. "This doesn't work for co-ops that have three years to go to maturity, and I always stress that," explains Howe.

To lock in the new rate, co-ops either agree to pay a slightly higher interest rate on the new loan or pay a fee, ranging from 0.5 to 3 percent of the new loan, to lock in the rate. At the time of the rate lock, the co-op also puts down a "good faith" deposit of 2 to 3 percent of loan, refundable at the closing. "That just ensures that the co-op doesn't walk away from the rate lock," notes Howe. "We will commit to the rate, but we want the borrower to commit" to getting the loan.

Domenick Tammaro, an attorney with Yonkers-based Smith Buss & Jacobs whose clients include Palmer Terrace, says that it makes sense for the co-op to seek a forward commitment. "If you have a bank that gives you the ability to lock today but not close until after July 1, when the rate reduces, you have your cake and eat it too. You have a rate that works and you are saving money."

By locking in a rate in May and not closing until November, Palmer Terrace saved $60,000 a year in mortage payments, says Tammaro, and lowered its interest rate from 8.8 percent to 6.66 percent.

The appeal of forward commitments is straightforward: buildings can reduce a line item cost in their budget at a time when other expenses are doubling and tripling, and lock in that reduced costs for a set period.

"For co-op boards, obviously, their fiduciary responsibility is to minimize expenses, but their mortgage tends to be 35 percent of their budget, so any time they can lock in 35 percent of their budget at low cost it pays to do that," observes Howe. "It's the one part of their budget they can control, unlike taxes or the cost of oil or labor cost."

In a recent agreement with NCB, a luxury co-op on Park Avenue lowered its mortgage payments by $40,000 a year. The building, which was paying an 8.16 interest rate on its existing mortgage, locked in a lower rate of 6.6 percent in June 2002 and closed on the new mortgage on November 1, 2002. The building, which last year had been paying $440,000 in mortgage costs is now paying $400,000 in annual costs.

Raphael Fink, a partner at the Finance Group, points out that, because of the New York City tax hike, the ability to lock into low interest rates is especially appealing. "For budget purposes, co-ops love it because they don't have to raise maintenance - this year and maybe not next year."

To illustrate his point, Fink offers the example of a 130-unit co-op in Riverdale overlooking the Hudson River. Last year, the co-op began working with the Finance Group and NCB to refinance its mortgage and develop a line of credit to pay for capital improvements. In May, the building will close on a new $7.5 million mortgage with a 6.41percent. interest rate, a significant reduction from its existing interest rate of 8.79 percent. The co-op locked in the lower rate in December and will close in May 2003.

"By the time they finish paying closing costs, they will end up with a million dollars in reserves and they don't have to raise the maintenance," notes Fink. The garage will be revamped, the terraces repointed and the overall look of the building improved. "The building is going to become a Class A building by the time the work is done. And, of course, unit values are going to go up significantly."