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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.

Rate Loan Term Original Loan Amount Amortization Monthly Payment
Current Loan 5.95% 10 Years $10,000,000 30 years $60,165.06
Proposed Loan 4.25 10 Years $9,690,000 30 years $48,004.42

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.