Learn about the pros and cons of a commercial refinance.
Is it time to refinance your commercial property? Do the pros outweigh the cons? As is true of any commercial property transaction, it all depends on the specifics of your property and what your goals are. We have compiled some of the basic information you need to determine if now is the time to refinance your commercial property.
There Are Many Potential Reasons to Refinance Commercial Property
There are a host of reasons that an individual or company might decide to refinance their commercial property. It might be as simple as refinancing to get a better interest rate or as complex as using the equity in their commercial property for a cash-out.
The Pros and Cons of Refinancing Commercial Property
Not all of the pros and cons apply to all commercial property transactions, but they should be considered when determining whether or not to refinance.
Pro: Lowering Payments
One of the most significant benefits of refinancing any property is to get lower monthly payments.
Con: Significant Upfront Costs
Yes, you could lower your monthly payment, but closing costs come along with refinancing, just as there were with the original real estate transaction. It is vital to confirm that what you save from the new loan will be more than you will pay in fees to refinance the loan.
Pro: You Can Improve Your Loan Terms
One of the most common reasons for refinancing commercial property is to take advantage of lower interest rates, whether because rates have lowered or because an entity or person’s credit has improved and qualifies them for better interest rates. However, other loan term improvements can apply, such as shortening or lengthening the loan term.
Con: Not All Commercial Loans Can Be Refinanced
It is possible that whether or not refinancing would work for a particular person or entity is irrelevant because their loan is not eligible. For example, Small Business Administration (SBA) 504 loans are not eligible for refinancing. It is wise to check with your current lender to determine if there are restrictions that prevent refinancing.
Pro: You Could Avoid a Balloon Payment
Generally speaking, commercial loans have a much shorter repayment period compared to residential mortgages. The average commercial loan must be repaid within five years, while residential loans often offer 30-year payment options.
As a result of this unique structure, commercial loans often include balloon payments. They are large, lump-sum payments that pay off the rest of the loan. When a company finds that their balloon payment is looming and cannot pay it, or it is not beneficial to use their financial resources to pay it, they might choose to refinance the loan and avoid the balloon payment.
Con: You Might Have to Pay a Prepayment Penalty
Some lenders charge prepayment penalties for paying off a loan early. Once again, this applies to some SBA loans. This could increase your costs to the point that the refinance does not save you money.
Pro: It Might Be Possible to Borrow Tax-Free Money
If you currently have equity in a commercial property, you could qualify for a cash-out refinance. This allows you to borrow more than you currently owe but less than the value of the property. You can then receive the difference between what you owe and what the property is worth in the form of a tax-free cash-out.
Types of Commercial Property Refinance Loans
Just as there are many commercial property loans, there are many types of commercial property refinance types.
SBA Refinance
The SBA has two types of commercial refinance loans. Both of them have a $5 million maximum.
- SBA 7(a) Loan. If the loan is for $150,000 or less, the SBA can back up to 85% of this type of loan, while loans of more than $150,000 and less than $5 million can be backed by as much as 75%.
- SBA 504. This loan requires 10% of the loan amount as a down payment from the borrower. The SBA backs up to 40%, and a Certified Development Company (CDC) backs up to 50% of the loan.
Commercial Bank Refinance
Commercial refinance loans are a standard product at most large commercial banks within the U.S. You can choose a straightforward refinance from a commercial bank. Still, they often have other refinance products, too. For example, they generally offer cash-out options for commercial loan clients that have equity in their properties.
Credit Union Refinance
Some credit unions are too small to offer commercial refinance loans to their members, but many are not. This can be an appealing option because credit unions can often offer lower interest rates than traditional banks. That said, the maximum amount of the loan is often smaller than a traditional bank, too.
Requirements for Commercial Refinance Approval
Your approval for a commercial refinance will depend on a combination of factors. They include:
- Credit scores. If you have business credit, then it will be taken into consideration. If you do not have business credit, then your personal credit score will be taken into consideration. In fact, personal credit scores are often taken into consideration even when a borrower has business credit.
- DSCR. Debt Service Coverage Ratio (DSCR) is essentially a term used to describe how likely you are to pay back your loan. This number is calculated by dividing the net operating income of your business by your annual loan repayments. The goal is a ratio of at least 1.2.
- Length of ownership. Some lenders require that commercial property is owned for a specific amount of time before being refinanced. ‘
- NOI. Net Operating Income (NOI) measures the gross income of a property subtracted by its operating costs. However, debt service is not part of the operating expenses used to determine NOI. The higher your NOI, the better your chances of commercial refinance approval is likely to be.
These are the most common factors lenders will consider, but there will likely be other factors. Talk to your specific potential lender to find out what your chances are of being approved.
Standard Fees and Costs of Refinancing Commercial Property
As mentioned in the pros and cons, one of the cons of refinancing a commercial property is that there are significant fees. If you plan to keep the property for the next twenty years, then the fees might not be unreasonable spread out over that amount of time, but if you’re only holding on to a property for another year or two, refinancing likely does not make sense.
Some of the standard fees you should expect if refinancing commercial property include:
- Prepayment penalties. Your current loan might include prepayment penalties that kick in if you refinance and pay off your commercial mortgage too early.
- Appraisal. While appraisals are sometimes waived, you will need to pay for an appraiser to verify the value of the property in most cases.
- Guarantee fee. If you are refinancing through the SBA, then you will need to pay a guaranty fee to your lender. The SBA charges this fee to the lender, but the lender almost always passes the cost off to the lender. This is a fee you pay both upfront and each year, but only on the amount of your loan backed by the SBA.
- Origination fees. This covers various lenders’ costs, including processing, funding the loan, and underwriting the loan. It can be a percentage of the loan or a flat fee.
- Credit report. When a lender is considering offering you a loan, they will check your credit and will generally charge you for that cost of accessing it. The cost is generally between $50 and $150.
Frequently Asked Questions About Refinancing Commercial Property
Q: What are the steps involved in refinancing a commercial property?
A: There are many steps, and they can vary by transaction, but generally, these are the things you will do to secure a commercial refinance package:
- Choose a lender
- Submit an application
- Provide requested information
- The lender underwrites the loan (i.e., they review and verify the documents you have provided, appraiser the property, review reports, etc.)
- The lender approves or denies your refinance request and notifies you of their decision. If you are denied, then you can start over with another lender.
- If you are approved, then the final step is closing. This is when you pay closing costs, sign all required documents, and complete all final paperwork.
Q: How many lenders should I consider before deciding who to refinance my commercial loan with?
A: Many banks could potentially approve your refinance request, including national banks, credit unions, lenders that exist entirely online, and government options such as the SBA and USDA. Each of these lenders have different programs, and we recommend you look at at least three options, but preferably consider five or more lenders before deciding on the right company to work with.
Q: Can refinancing commercial property provide a positive cash flow for my company?
A: It is possible to use a cash-out commercial refinance to get funds. However, this only applies if you have equity in the property. While it will not guarantee any future positive cash flow, the money you cash out of the equity can be used for business improvements and investments to help provide an eventual positive cash flow.
Q: How is a commercial refinance different than a residential refinance?
A: There are two main differences. The first is amortization. This refers to how both types of loans are paid off. The most important issue here is that home loans generally have 15- to 30-year terms, while commercial property loans can be as short as five years.
The second difference is the requirements for a loan. Put simply, the requirements for an individual to take out a loan are significantly different from the requirements to take out a commercial loan.
Q: Is it always worth refinancing commercial property if it means lower monthly payments?
No. If you only plan to own the property for another year, the cost of refinancing could be much greater than the savings you would experience with lower monthly payments.
Think you’re ready to refinance?
This is a big step. You’ve already purchased your commercial property, but now you just want to move things around so that they make the most financial sense. If you’re looking to see where the numbers fall for a commercial refinance, try out our free commercial property calculator.