Things to Weigh Before Taking the Refi Plunge

Interest rates have been rising since late 2015, and they’re poised for another uptick next month. That’s a major consideration for co-op boards when they set out to refinance their underlying mortgage. But there are many other pieces to the equation for boards taking the refi plunge. 

A big one is finding the most favorable prepayment penalty, says Gregg Winter, president of Winter & Company Commercial Real Estate Finance, which handles refinances. “It is possible to get a 10-year fixed-rate loan with a penalty of 3 percent of the remaining loan amount for the first three years, 2 percent in the next three, 1 percent in the next three, and none in the last year,” Winter says.

Prepayment penalties are essentially insurance for the lender that guarantees a certain return on investment. When used in co-op loans, they are usually structured in one of two ways: 

The step-down structure specifies a percentage that must be paid on the remaining balance. That percentage gets smaller as the loan gets closer to maturity. 

Yield maintenance penalties are more complicated and can be far more costly. The penalty is a calculation of how much the lender is losing as a result of your early pay-off, based on the difference between the loan interest rate and current interest rates. In a highly simplified example, say the interest rate on your current mortgage is 5 percent, and current rates for similar loans are 4 percent. If you want to pay off the loan two years early, the lender figures it will lose 1 percent per year because of the early pay-off, and charges a penalty of 1 percent times the principal balance, multiplied by the number of years left on the loan. 

In a rising-rate environment like the current one, the yield maintenance penalty is less of a concern, says Steven W. Birbach, president and chief executive of Vanderbilt Property Management. “The way the yield curve works, if they’re getting more money in the current market, it doesn’t hurt you as much.” 

It’s just one of the many pieces of the equation co-op boards must consider when they try to decide if the time is right to refinance their underlying mortgage.