Dealing with Prepayment Penalties

Prepayment penalties can be a pain in the neck for commercial real estate investors seeking to refinance their properties. However, it may be worth the penalty if you are able to refinance at a much lower rate, higher dollar amount, or both. This article will explore how you can address these issues and determine if it is worth your time to refinance your commercial real estate property!

It can be difficult to find yourself in a low interest rate environment while being stuck due to 3-4% flat penalties, yield maintenance or defeasance prepayment penalties. The latter two make the lender indifferent if you prepay at a higher interest rate, but penalize you for attempting to do so at a lower interest rate. They effectively result in the lender obtaining every penny – or more – of the original loan amount at the set interest rate.

Overall, the refinancing decision remains a strictly mathematical one. Borrowers that have an immediate need for cash that they can reinvest at a substantially higher rate of return than the penalty that they are incurring may find it worthwhile. Meanwhile, others that are simply looking to save some money may find it is not worth the effort. Others may even try to predict future interest rates. For example, those holding a $15,000,000 mortgage may feel stupid paying a giant prepayment penalty, but lower interest rates could save them much more in the long run if interest rates move high.

In the end, this is an important decision to make. Whether it is a mathematical choice or a gamble on interest rates, it is something that should not be ignored. Prepayment penalties may seem unreasonably high now, but the opportunity cost of avoiding them could end up costing you much more!

Popularity: 14% [?]