DEFEATING DEFEASANCE, A PREPAYMENT PENALTY THE SIZE OF JUPITER

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Although defeasance can be an overwhelming process, there are steps co-op boards can take to lessen the pain and avoid sticker shock.

Try to get out of it. Despite the tough rules, there can be ways around it, according to Samson. Read the paperwork. Look for a mistake or glitch in the documents that offers a borrower a way out of the penalty. "Find your loophole and drive your truck through it," advises Samson, who says that he has read mortgage agreements that offer escape clauses from prepayment penalties.

If that doesn't work, see if the lender might allow you to pay early without a penalty. Many banks, especially smaller regional ones, have liquidity problems and could be willing to let a borrower pay back a mortgage, which would improve the bank’s balance sheets. It's a question of understanding the business needs of the mortgage-holder, asserts Samson.

Do the math. Many co-ops are eager to refinance, but defeasance adds an expensive variable to the equation. A board should ask a professional, such as a defeasance consultant or attorney, to crunch the numbers to find out exactly what refinancing would cost. Some defeasance policies have a built-in window in the last few months of the loan where there is no penalty. By waiting, a building could save time and money, but that could mean foregoing the low interest rates. In other cases, although the penalty hurts, the building will save money in the long run by refinancing.

Decide if defeasance may be worth it. Although defeasance can be a headache, the rates are generally lower than other mortgages and, with interest rates so low now, it is likely rates will be higher in 10 years when the mortgage matures, so a co-op might actually make money down the road. But before the building signs onto a mortgage with such a clause, board members should be well aware of the process involved with refinancing. "I know people who go through a defeasance loan and say, 'I'm never going through that again,’ but that's not necessarily the best choice," says Schissler.

Be prepared. Once the defeasance process is set in motion, it can quickly become difficult and costly. Long before co-op board members begin refinancing, you should discuss the work and fees involved and decide if you're up for the task. If you ultimately decide to defease you loan, you should assemble a team of experts to steer you through the process.

In hindsight, Racht wishes her clients on West End Avenue had walked into the process more aware of what they were facing. "I would have had them have a bigger discussion about it," she admits. "I don't know if I would have advised one way or another, but I certainly would have advised them to discuss it."

Adapted from Habitat March 2012. For the complete article and more, join our Archive >>