Negotiating Prepayment PenaltiesSeptember 2010 – Newsletters In the Zone
Many borrowers seeking to sell or refinance their existing commercial mortgages are now finding themselves face to face with giant prepayment penalties. While you can attempt to negotiate with your lender for a waiver or reduction of the prepayment penalty when you are refinancing or selling the property, the best time to negotiate prepayment penalties is before you sign the loan documents.
There are a number of ways to make your prepayment penalty less costly:
- Types of Prepayment Penalties
Before you agree to a prepayment penalty, you should be certain that you understand how it will be calculated. Lenders use several types of methods to calculate prepayment penalties. For instance, lenders may charge a flat fee or a fixed percentage of the outstanding loan balance at the time of prepayment. Lenders may also use a yield maintenance formula, which basically results in the lender receiving all the interest it would have received had the loan not been prepaid. Yield maintenance formulas are complex and can be difficult to calculate, so it is important borrowers understand how they work before agreeing to a prepayment penalty based on such a formula. It may make sense to crunch some numbers upfront so you can quantify the prepayment penalty before agreeing to it.
- Term of Prepayment Penalties
Shortening the term for which prepayment penalties apply can also decrease the cost of prepayment penalties. Ideally, your prepayment penalty will decline or disappear with the passage of time. For instance, you may be able to negotiate a prepayment penalty that starts at five percent but declines by one percent annually and then remains at one percent through the final year of the loan term - or disappears altogether.
- Excluded Transactions
There are several circumstances where a lender may agree upfront that the prepayment penalty should not apply: for example, if you are prepaying your loan in connection with a refinancing with the same lender or you are selling the property to a third party. In addition, you should attempt to exclude the situation when the mortgage debt is accelerated as the result of the borrower’s default in making the mortgage payments.
Unfortunately, it is not uncommon for borrowers to give prepayment penalties little thought until it comes time to sell the property or refinance the loan. But by negotiating the terms of prepayment penalties upfront, you can save money down the road.
For more information, please contact Lauren W. Taylor at 215.918.3625 or [email protected].