Refinancing Your Commercial Mortgage

When interest rates are at historic lows, you probably think about refinancing your home. But don’t forget about the mortgage on your office, shop, or warehouse. The banking doldrums may have a silver lining for companies carrying mortgages made even just a few years ago.

Before you get too excited, this is not an opportunity to refinance every loan your business has. In fact, many business loans cannot be refinanced. Lines of credit, for example, typically charge a floating rate of interest, so they are already benefiting from lower rates overall. Refinance opportunities are limited to fixed-rate loans, which are typically used for assets such as real estate, also called commercial mortgages or, in some rare cases, asset-backed loans.

How to Decide

The decision to refinance a commercial property loan is similar to refinancing your home. There are significant costs involved, so weigh the monthly savings against the upfront expense.

Need a rule of thumb? If you can reduce your rate by 1 percent and plan to keep your property for more than three years, it’s probably worth it. Bigger loans will generate bigger savings, of course. Pencil out the specifics to be sure, and when you do, consider these expenses:

• Appraisal: Any real estate that is collateral for a loan will have to be reappraised. The cost for a commercial appraisal is significantly higher than a residential appraisal. Plan to spend $2,000 to $4,000 on the appraisal.
• Closing costs: If it takes an attorney to close the loan in your state, count on another $1,000 fee. You may be able to negotiate it down, but most lawyers charge more for commercial loans than for residential mortgages.
• Origination fees: Banks are hurting for income these days, so most will tack on a half percent to 1 percent “origination fee.” This is simply a fee that offsets the cost to set up your new loan. It can be negotiable: Getting offers from several banks is the best way to get it waived.
• Inspections, surveys, title searches, insurance, and more: Talk with your banker in advance about these various fees and expenses. Ask the bank to draw up an estimate of all expenses required and to designate which are due prior to close and which can be rolled into the loan.
• Time: Don’t forget that your time (and that of your staff) has value. You’ll spend 20 to 40 hours working through a refinance, and more if there are problems.

For a quick calculation, figure the total cost to refinance as $10,000 plus 1 percent of the loan value. On a $1 million loan, that’s a total of $20,000, or about what you’d save in interest over two years on a 1 percent drop in rates. Likewise, it would take three years to get ahead if the loan amount is only $500,000.

Beware the Criteria

Two obstacles could get in the way of your refinance: lower property values and a lack of cash flow. In banker lingo, that’s known as “adequate collateral” and a good “debt-service coverage ratio.”

Collateral value is easy enough to understand: Your property must appraise for more than you wish to borrow. Check with a local commercial real estate agent before you spend money on an expensive appraisal.

The second criterion, debt-service coverage ratio, is simpler than it sounds. At the end of each month, you must have more cash left over than you will need to pay back the loan. How much is enough? Generally, multiply the loan payment by 1.25 to get a benchmark. If you’re making the payment now (at a higher rate), chances are good that you’ll meet the needed coverage ratio at the lower interest rate.