How and When To Do Mortgage Refinancing

Are you thinking about refinancing your commercial mortgage but are not sure if you should?

In this blog, we’ll talk about whether it makes sense to take out a new mortgage to pay off your existing one, depending on your situation. You will also learn about the general eligibility requirements for commercial refinancing, along with other information that can help you make a decision.

When should you refinance your commercial mortgage?

There are many reasons why commercial property investors might want to refinance their loans. However, it’s worth looking at this financial move if you think you can take advantage of these benefits:

1. Avoiding the dreaded balloon payment

As you already know, commercial mortgage loan terms are much shorter than residential mortgage terms, lasting only 2 to 10 years instead of 15 to 30 years.

And at the end of the term, you need to pay a large sum (called a ‘balloon payment’) for the rest of the loan amount. Not quite prepared?

Not ready to lock in your capital in the property? Refinancing your loan might make sense before this balloon payment comes due, depending on your circumstances.

2. Getting lower interest rates or better loan terms

Refinancing might help you get more favorable terms or better interest rates. This can lower your monthly payments and free up your cash flow for other investments or business improvements.

If your current commercial mortgage has an adjustable rate and rising rates, you may consider switching to a fixed-rate loan for stability. You can also refinance into a new loan without a prepayment penalty.

3. Getting cash out for property improvements

Some investors leverage the equity they have so far built up in the commercial property by refinancing the loan. Cash-out refinancing allows you to borrow more money than what you currently owe on the property.

You can then use the difference between the amount you borrowed and the amount you owe to fund property improvements to help you get higher rent and ultimately increase your profits.

How do you refinance a commercial property loan?

If you think you can benefit from refinancing your commercial mortgage, the next step is to find out what eligibility requirements you need to fulfill to qualify.

The actual requirements vary depending on the lender, but in general, you’ll need to show the following:

1. Your property’s net operating income – Take the gross income you make from the property and deduct all operating expenses, not including debt service. This is your net active income or NOI. The required NOI varies depending on the lender, type of business, property size, and loan program, but the higher your number, the better your chances of getting approved for refinancing.

2. Operating history – Most lenders will only approve your refinancing request if you show that you have been operating the property stably for a few years. Most lenders require at least two years of operating history.

3. Business credit score – The minimum score required by the Small Business Administration is 155 (this is out of 300) for SBA 7(a) loans. Banks and private lenders have different credit score requirements. The higher your business credit score, the higher your chances of getting refinancing approval.

4. Debt service coverage ratio or DSCR – The DSCR is a metric that shows if the property makes enough cash to pay its mortgage. Most lenders want to see a DSCR of what least 1.2, but 1.5 is ideal.

5. Business and personal documents – The detailed documentation you will need to refinance your commercial mortgage will depend on the lender you want to work with. That said, it’s best to have the basics ready, including bank statements for the property and your accounts, business tax returns, personal tax returns, the latest business operating ideas, rent roll, and information on your other property holdings.

Beware of steep closing costs.

Before you finally decided to refinance your commercial real estate asset, make sure you understand the costs involved in the deal to see if you’re saving money and if refinancing is worth the effort. The actual numbers vary, but you can expect to pay these standard closing costs if you want to refinance:

• Prepayment penalty (depends on your lender)
• Guarantee fees of anywhere from 0.25% to 3.75%
• Application fees (depends on the lender)
• Credit report fees ranging from $50 to $150
• Appraisal fees upwards of $2000
• Origination fees (at least 1% of the total loan amount)

Conclusion

Refinancing may be a good idea if you want to secure lower interest rates, get better loan terms, or access the equity you’ve already built up in the commercial property and use the money for renovations to improve the asset's value.

Do note that the information presented above is simply foundational knowledge. It’s best to talk to a commercial property financing expert for customized advice based on your specific circumstances.