Refinancing Woes: Asking the Wrong Question

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Question: Our board has been discussing refinancing our underlying mortgage for about a year. We almost did it about nine months ago when rates were pretty low, but one member of the board convinced everyone that rates would fall further. Our current loan comes due in about six months, and we need money for some façade work in the spring, but this same board member still wants us to wait for lower rates. Do you think that rates will fall even more?

Answer: If I truly knew the answer to your question, I’d be dictating it to my assistant on the veranda of my oceanfront villa in Tahiti, Mai Tai in hand, because I would have made so much money with that knowledge! With that grain of salt out of the shaker, I’ll give you my thoughts.

First, I think that you are asking the wrong question. You tell me that you need money for work that you must complete next spring. Have you discussed this work with your managing agent? Do you have an engineer’s assessment of the scope of work required? Do you have any bids from reputable contractors to help you estimate the cost of the project? Have you and your managing agent laid out a project schedule so you can start and finish as quickly as possible? Have you alerted any affected shareholders? Has your attorney advised you about necessary clauses in any contractor documents?

The answers to any of these questions could uncover issues whose financial impact could far outweigh the savings from a lower interest rate. Also, many contractors will grant price concessions to customers who commit before the end of the year for spring projects.

Second, I think that you are asking the wrong question. Have you collected and organized all your building records so you will be able to answer lender questions? Has your attorney reviewed your existing loan documents to see whether you can refinance now and, if yes, if there is a prepayment penalty? Has your attorney given you an estimate of closing costs? Have you discussed your plans with your accountant and asked for advice on loan format and help in calculating any prepayment penalty? Have you consulted a reputable mortgage broker for information about the current state of the underlying mortgage market?

Third, I think that you are asking the wrong question. Have you calculated what saving a few basis points (1 percent = 100 basis points) would mean for your cooperative versus what a sudden rise of 25 or 30 basis points might do to your financial plans? Interest rates move up or down as economic factors change around the world. They also move in response to uncertainty, but those moves are usually up. So, if the market is unsettled (as it is now), you are less likely to see a drop in rates.

When rates do fall, they rarely drop precipitously. Instead, they tend to decrease gradually. It is true that a persistent downward trend can add up to something significant. However, it is the other direction that you should worry about. Rates can increase slowly if credit demand is rising, but they can jump quickly in response to some troubling event. After a sudden spike, it is not at all uncommon for rates to remain in the new, higher range for some time before slowly falling back to their earlier level. Trying to time the market is a risky game that even the professionals who do it for a living frequently lose. You shouldn’t gamble with your cooperative’s financial future.

Having thrice sidestepped your question, I’ll now try to answer it. However, I caution you to remember what I said at the beginning of this column regarding the value of my opinion. My best guess may be a little more reasoned than someone else’s, but it remains a guess. That said, let’s consider several factors.

On the one hand, you could expect the Federal Reserve chairman to keep rates low to support both the struggling economic recovery and the re-election campaign of his boss. In addition, our less-than-robust economy has dampened credit demand, which will tend to keep rates low. On the other hand, there are early signs of inflation in some commodity prices, which hints at higher rates. And let’s not forget our spendthrift friends across the pond whose fiscal woes have infected world financial markets with a bad case of the jitters.

Distilling all of this into an opinion, I would suggest that we are in for an extended sideways waddle with, perhaps, an ever-so-slight downward bias. However, if one of the important European countries defaults on its debt, or some lunatic stages a major terrorist event, expect rates to bounce skyward. So, if I were sitting on your board, I’d be arguing for getting your show on the road sooner rather than later.