Ability To Refinance Explained

Ability To Refinance Explained

Refinancing a loan can be an invaluable strategy to save money. People generally refinance loans on their commercial real estate projects to either get a lower interest rate, or more favorable loan terms. Refinancing a loan works by taking out a second loan to pay off the first loan, and is done when the second loan can provide better terms than the original.

There are several key benefits of a commercial real estate refinance including...

Avoiding Balloon Payments

Commercial real estate loans generally come to term much faster than a residential mortgage. The loan term on a commercial real estate loan can be as short as two to five years. At the end of this loan term you are required to pay the rest of the loan off in a lump sum, known as a balloon payment. These balloon payments can be avoided if the loan is refinanced before the payment is due.

Making Property Improvements

It is possible to get more money out of your property if you have begun to pay off your loan already. This is called a cash out refinance. For example, if you have a $500,000 property and a $300,000 loan, you can refinance to a $400,000 loan and you get to pocket the extra $100,000 tax-free. This is often used to make improvements on the property to increase the value and rent being paid, or used for other investment purposes.

Obtaining Better Loan Terms

It is sometimes possible to receive better interest rates when refinancing, but that is not always the case. There are other loan terms that are worth refinancing for, such as switching to a fixed-rate loan if you think interest rates will rise, or refinancing to a loan with no prepayment penalties if you plan to pay it off early.

But refinancing is not all good, there are downsides to refinancing as well such as…

Closing costs
Just like the original loan you took, the second loan will come with closing costs. In some situations these costs outweigh the money being saved through the refinancing, making it infeasible.

Inability to refinance
Some loans are unable to be refinanced. For example, US SBA 504 loans are unable to be refinanced. Other loan programs may have similar restrictions, this is something to keep in mind when applying for a loan and agreeing to the loan terms

Prepayment penalties
Some loan terms include a prepayment penalty. This states that if you pay off your loan before the full term of the loan is up there is an additional fee. This is another thing to weigh against your possible savings when considering whether or not to refinance. If the prepayment fees outweigh your savings it is likely not a good idea to refinance.

Conclusion

There are three main options when it comes to refinancing a commercial property loan. First, there are government backed refinance loans. In these types of loans the government agrees to cover a portion of the loan in the event that the borrower defaults. This allows lenders to give out more favorable loan terms as there is less risk involved. Next are conventional commercial refinance loans. These are typical loans done through a mortgage lender or bank. Last are commercial cash-out refinance loans. As mentioned previously, these types of loans allow a borrower to take out more than their loan is worth in a new loan, so they get capital to spend at their discretion. This is often used for property improvements or other investments.

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About the Author

Eric Bergin is the founder of TSM. He realized that there was a need for real estate financial models that were more than just generic templates. He wanted to create a personalized product for his customers that would ensure success for them and their company. Please reach out to him if you have any questions about refinancing your laons or if he can help you with your modeling needs.