At Refi Time, Boards Need to See the Big Picture

Refinancing the underlying mortgage is one of the biggest challenges – and opportunities – co-op boards ever face. Do it right, and you save big money. Do it wrong, and you get locked into a draining financial straitjacket. Deciding when – or if – to refinance is a calculation with many moving parts. 

Some boards fixate on one of the biggest: the prepayment penalty, that sliding sum that has to be paid off to release the borrower from a mortgage that has not yet run its course. Instead of focusing too narrowly on the prepayment penalty’s dollar amount, however, boards should look at the bottom line: how would the new loan affect the co-op’s debt service? Or more simply, would the monthly payment be any more onerous? And is the new loan accomplishing the stated goal? 

“I try and look at the big picture,” says Steven W. Birbach, president and chief executive of Vanderbilt Property Management. “Even if you have a large penalty, if you include it in your new mortgage amount, and it still keeps your debt service relatively stable for the next 10 years, that’s a good thing for shareholders.” 

The board should also keep in mind that the penalty is an interest payment and therefore qualifies as a tax deduction for shareholders. 

Another way of thinking about a new loan offer is to look at how much in interest savings the co-op will miss out on if it doesn’t refi and pay the penalty now. That’s the approach used by Steven Geller, managing director at Meridian Capital Group, a commercial real estate finance company. He commonly presents boards trying to make that calculation with detailed comparison charts showing the estimated interest rate savings, and how long it will take to recoup any penalty incurred. Geller notes that he can offer co-ops a 10-year loan on a 30-year amortization, where the first two years are interest-only. “So you can save back a good portion of the penalty that you paid in the first couple of years and replenish your reserve accounts,” he says. 

Some co-ops do interest-only loans for the entire 10-year term, but most do not. “We like to see amortization to protect the co-ops,” says Harley Seligman, senior vice president at National Cooperative Bank. “When rates go up, you’ve paid down some principal. At the end of 10 years, you’ve probably paid off about 20 percent of the loan amount.” Birbach adds that paying off some of that debt every year means the co-op will be well positioned to go back into the market at the end of 10 years. 

For very high-end co-ops, however, the mortgaged amounts are usually small compared to the value of their buildings. Therefore, it doesn’t make sense for those shareholders to pay down more principal, says Mary Frances Shaughnessy, managing director of Tudor Realty Services. “Why pay today so someone 30 years from now doesn’t have a mortgage?” she says. 

Shaughnessy also prefers to work with banks making portfolio loans – meaning they aren’t sold off to the secondary market. Because the banks hold on to the loans, they have much more flexibility. “If you go back to the same bank [to refinance],” says Shaughnessy, “you can frequently get them to cut the prepayment penalty in half.” 

Either way, with interest rates rising – and another uptick expected in December – boards should listen when their property managers suggest that now might be the time to consider refinancing. “We’ve had situations where we begged boards to refinance last year, because we knew rates were rising,” Birbach says. “Over the last 18 months, rates are up a point or more. But for these boards, the loans weren’t coming due, and they didn’t want to pay the penalty. Now, they’ll be paying more.”