For 30 years we have arranged private party loans without basic early pay off fees, also called Pre Payment-Penalties... And actually, our ambition to provide the best loans with the best features is what helped us grow our company with thousands of raving fans. The borrowing community appreciates our efforts to keep originations and service costs reasonable AND keep ancillary costs—such as early pay off fees--to a minimum.
Pre-pay penalties are simply a way for lenders to make more money and to guarantee a minimum yield on the loans they write. The prepayment fee discourages early payoff through a refinance or sale and represents a large loss to the real estate owner if not accounted for when applying for a loan. Always ask for a detailed written explanation of any prepayment fees when applying for a loan or signing loan documents. Below is the essential information you need to know about the prepayment penalties.
Our Yield Maintenance Agreement
Private Client Investments, Inc does not charge a penalty, but rather wants to earn a minimum amount of interest. For instance, if we write a loan for 24 months we want to be assured that we earn a minimum of 12 months of interest. This means that if the loan is refinanced after 12 months there is NO penalty or added interest owed us. However, if the loan is refinanced in month 11 then the borrower is asked to pay us the remaining 1 month’s worth of interest.
However, the typical early payoff fee for many lenders is if the property is refinanced prior to the 1 year (and sometimes the terms is for the whole 2 years) the penalty is equal to 6 months of interest calculated on 80% of the remaining loan balance. The 6 months worth of interest is a heavy price to pay and is rarely negotiable.
Commercial loan prepayment penalty
The prepayment penalty is generally the feature for most fixed commercial loans that can significantly impact the total cost of the loan. They are the additional fees that are charged if the borrower is trying to pay off the loan prior to the maturity date. The purpose here is enough to protect the expected profit of the lender on loan.
So if the loan is to be paid off early, the lender will not receive the total amount of interest that he was scheduled to receive during the loan term. This is why the prepayment penalty exists, which will help cover the losses.
Commercial loans with prepayment penalties
Generally, fixed-rate commercial real estate loans come with a prepayment penalty for conventional loans, mortgage-backed securities, multi-family homes, etc. The floating rate commercial real estate loans might not have prepayment penalties.
This is because the borrower will review the feature of the commercial loan under any situation. If the loan has got a prepayment penalty, then the structure and the fees must be discussed in detail in the term sheet.
Assessing the prepayment penalty
When a commercial real estate loan comes with a prepayment penalty, it means it is to be assessed before the loan is actually provided. The lender will consider the time frame before the maturity period for assessing the prepayment penalty period.
Most of the lowest generally use this power to decide the prepayment fine to be paid once the property is sold. In case the property loan is completed, then the loan must be paid off within the prepayment penalty period with proceeds from the sale of the property.
Prepayment penalty
Commercial real estate loans have got different penalty types. The details of the same are here.
Lockout periods
Generally, commercial real estate loans come with prepayment penalties. However, some also have got the lockout periods which means a specific period of time during which the borrower cannot repay the loan in no condition or situation.
Thus the borrowers must be careful when looking at the commercial real estate loans that come with long lockout periods. This is because, in the end, you might face difficulty in selling the property before the lockout period is actually over.
This happens when the commercial real estate loan isn’t allowed to be prepaid within the full loan tenure. The lender won’t allow the Prepayment in any form. The borrowers need to wait until the period expires if they want to pay off the loan before maturity.
As it is impossible to pay off the loan during the lockout period, the prepayment penalty and the borrowers must consider the lockout period carefully. No doubt, the lockout period cannot be avoided, so taking out the loan within the lockout period will restrict the future options related to the property, like the sale or refinancing.
Fixed Prepayment penalties
Such penalty charges are considered when a commercial loan is paid prior to maturity or within the applicable timeframe during which the penalty can be effective. The fee is typically structured as a percentage of the remaining loan amount.
For instance, if the loan has got a prepayment penalty of 3%, then the borrower would have to pay back the remaining balance plus 3% interest. If you want to pay off the loan in full, a prepayment penalty is based on the leftover loan balance. Thus the penalty will decrease over time.
Step-down prepayment penalties
Such penalties are charged on the percentage of the remaining loan balance like a fixed penalty. But here, rather than maintaining the fee at a percentage for the duration of the penalty, the penalty decreases over time. This means the step-down penalty is schedule increments which usually can be 1% for a year.
In some cases, commercial loans might have a soft step-down prepayment structure. It works great for standard step-down Prepayment. The initial percentage can be lower and will decrease at a slower pace. Besides, this type of penalty can actually be advantageous as the person is expected to pay off the loan after a specific amount of time.
Yield maintenance prepayment penalties
It is calculated by solving the present value of the future, and the lender is expecting to collect, Once the loan is carried through the end of the prepayment penalty period. As most of the factors can influence the present value to the future value, the calculation can be quite difficult. This is carried out by the lender, who utilizes yield maintenance frequently.
Defeasance prepayment penalties
Herein, there is a use of government-backed securities to maintain the lender’s identical return rate. The bond coupons help you replace the mortgage as collateral for collecting the interest from the bonds rather than just from the commercial loans.
The treasury bonds herein are used normally because of the predictable nature of the coupon payments. At the same time, defeasance is used primarily with commercial mortgage-backed securities or life insurance company loans. In such situations, defeasance laws or lenders produce identical expected return rates.
Although it is not a typical option, the borrower selects to pay off the mortgage during the defeasance period. As the penalty process can be difficult to understand, there are accountants and other professionals involved in the process.
Negotiations for a prepayment penalty
No doubt, commercial loan prepayment penalties can be negotiated. However, to a certain extent, there are different situations in which the borrower will be able to.
A shorter duration will significantly reduce the penalty duration
Getting a smaller fixed or set down a penalty in exchange for a higher interest rate
Get an alternative form of prepayment penalty, which can be economically beneficial and will help save money
Give the assurance that the loan is assumable, which means it will allow the transfer of the property without actually paying off the original loan
The prepayment penalty can be negotiated in the proper manner after reviewing the term sheet in detail. Besides is, before you sign off any documents, it is essential that you have a clear idea as to how it will work or what you can do to negotiate with the lenders about the prepayment penalties and other aspects.
When you have a clear idea, it will be possible for you to get the deal at a fair rate. When you research well to identify the experts who are there to ensure you have proper support and are capable of getting the loan amount, that will help keep everything under control.
Based on your requirements, you must contact the lender that enables you to save money while ensuring the prepayment penalty is low and the deals are low level.
Conclusion
Financing can be complex, but talking to the right people can help you understand the different aspects of obtaining financing for a more simple and stressfree path. Having a good idea about it all is the key. You can research well to find the lenders or the experts who can help you understand things well.
At Private Client Investments, we will walk you through all your options and discuss the consequences in depth to help you make the decision that’s best for you.
We offer highly personalized investment opportunities based on your current financial situation. Flexible with terms and conditions, our financial experts provide creative solutions to structuring deals that benefit all parties, unlike our competition.
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