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Mortagagemortgagelender No Best Mortgage Rate Average 30 Year Fixed Mortgage Rates Drop To 2010 Lows In September Examiner Com Mortgage Mortgage Lender Your Multi-family finance connection

Mortagagemortgagelender No Best Mortgage Rate Average 30 Year Fixed Mortgage Rates Drop To 2010 Lows In September Examiner Com Mortgage Mortgage Lender

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A simple payback analysis would show that Mike is saving $19,804.78 per year or $59,414.35 over the remaining 3 years of his current loan.   This method of analysis shows that it is is pretty much a wash between the cash flow savings and the cost of the prepayment penalty.

While comparing the payments is a good way to evaluate the refinance it ignores the fact that part of your payment isn’t really a cost, but a reduction in principal.  Therefore, a more complete method would be to compare the different interest payments under the current and proposed loans.  For this analysis, we will need to run a full amortization schedule for each loan and compare the interest payments over the next three years.   Doing this will show us that under the current loan Mike will be paying $357,119 in interest over the next 36 months, while under the proposed loan he will be paying $271,069.   Therefore, in this second method of analysis the proposed loan will save make $86,050 in interest over the remaining term of the loan vs the $60,000 cost of the prepayment premium.

Comparing the savings under each scenario to the cost of the prepayment premium/penalty shows that refinancing is either a wash or saves Mike money to refinance.   Someone might say we are not considering the other transaction costs in this analysis; but since these costs will have to be paid at refinance in 3 years anyway we should be able to ignore them in this cost benefit analysis.

In either analysis, Mike gets some additional benefits besides the payback.   First, he gets the benefit of the additional cash flow in his pocket; while the costs of the refinance are part of the new loan, so his personal cash flow is increased, while the costs are deferred for 10 years.  Second, he gets to lock in his rate for an additional 7 years at historic low rates and, therefore, eliminates the risk that rates will increase before he refinances.

I have focused this analysis on a simple step-down prepayment, but it can also be used in the case of a yield maintenance prepayment premium.   The principles are the same, just the numbers are different.

Let’s use another example, I have another client; call him Tom, who bought a property 8 years ago and took out a loan for $10,000,000.  The loan was a 10-year balloon mortgage at 5.95% with a 9 ½-year yield maintenance period.    Today he has an unpaid mortgage balance of 8,778,773 and a yield maintenance prepayment premium of 800,692 (9.12% of the outstanding principal balance).     Let’s look at what would happen if he refinanced today.

In order to refinance the loan today, Tom would have to borrower $9,690,000 to pay off the existing loan and pay the prepayment premium and transaction costs.

The simple cash flow payback analysis would show that Tom would be saving $12,160.64 per month or $291,855.36 over the remaining 24 months before his yield maintenance expires and he can refinance with no penalty.  The interest rate payback analysis show you that under the current loan Tom will be paying $1,192,271.40 in interest over the next 36 months while under the proposed loan he will be paying $821,647.11.   Therefore, the proposed loan will save him $370,634.29 in interest over the remaining term of the loan.   Comparing these savings to the prepayment penalty of over $800,000 shows Tom should not refinance the loan, yet.

This analysis is helpful, and for borrowers who are focused on cash flow it may be about all the analysis you need.   However, this analysis does not really ask the correct question.   What a borrower is really trying to determine is not to keep the current loan or refinance today, but to refinance today or at a future time, usually when the current prepayment penalty expires.   The payback analysis ignores a couple of important facts:  first, the fact that the balloon balance and therefore borrowers equity are different under the two loan scenarios; second, it ignores where interest rates will be in the future when the current loan matures.   In order to take these facts into account, you need to make a more complex calculation that includes numerous assumptions.   A future post, I will be addressing this issue.   In the meantime if you need assistance analyzing whether you should refinance your existing loan, please feel free to contact me.

This article was written by Adam Klingher, SVP of Centerline Capital Group’s Midwest Lending Office.   If you have any questions about the article or would like him to run an analysis, you can talk to him at 847-421-2217.

The opinions reflected in this article are all personal opinions of Adam Klingher and do not necessarily represent the opinions of Centerline Capital or any of their lender relationships.

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