Prepayment Penalties in Commercial Real Estate Financing

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The Commercial Real Estate Financing industry (CRE) is growing with every passing day. There are increasing numbers of investors who are bringing in the money that can be used for the development of the spaces that can fulfill the needs of the businesses. But not every time can the investors have the cash readily available to them.

In such instances taking the loans works great for them. Commercial real estate loans come with a certain amount of interest which has to be paid in a timely manner. In case the borrower wants to clear the debt in advance, there will be a prepayment penalty which is a fee that will be charged when trying to repay the loan early.

When the lender issues the loan, they will want to get the maximum profit within a certain amount of time. The prepayment penalty is a way of compensating. It helps cover up the losses they will suffer if the loan is paid off early.

This is why it is pretty essential that you have a clear idea about the prepayment penalties and other aspects before taking a loan from a commercial real estate lender. The guide here has described in detail all the essential information you need to know about the prepayment penalties.

 

Commercial loan prepayment penalty

The prepayment penalty is generally the feature for most fixed commercial loans that can significantly impact the total cost of the loan. They are the additional fees that are charged if the borrower is trying to pay off the loan prior to the maturity date. The purpose here is enough to protect the expected profit of the lender on the loan.

So if the loan is to be paid off early, the lender will not receive the total amount of interest that he was scheduled to receive during the loan term. This is why the prepayment penalty exists, which will help cover the losses.

 

Commercial loans with prepayment penalties

Generally, fixed-rate commercial real estate loans come with a prepayment penalty for conventional loans, mortgage-backed securities, multi-family homes, etc. The floating rate commercial real estate loans might not have prepayment penalties.

This is because the borrower will review the feature of the commercial loan under any situation. If the loan has got a prepayment penalty, then the structure and the fees must be discussed in detail in the term sheet.

 

Assessing the prepayment penalty

When a commercial real estate loan comes with a prepayment penalty, it means it is to be assessed before the loan is actually provided. The lender will consider the time frame before the maturity period for assessing the prepayment penalty period.

Most of the lowest generally use this power to decide the prepayment fine to be paid once the property is sold. In case the property loan is completed, then the loan must be paid off within the prepayment penalty period with proceeds from the sale of the property.

 

Prepayment penalty

Commercial real estate loans have got different penalty types. The details of the same are here.

  • Lockout periods

Generally, commercial real estate loans come with prepayment penalties. However, some also have got lockout periods which means a specific period of time during which the borrower cannot repay the loan in no condition or situation.

Thus the borrowers must be careful when looking at the commercial real estate loans that come with long lockout periods. This is because, in the end, you might face difficulty in selling the property before the lockout period is actually over.

This happens when the commercial real estate loan isn’t allowed to be prepaid within the full loan tenure. The lender won’t allow the Prepayment in any form. The borrowers need to wait until the period expires if they want to pay off the loan before maturity.

As it is impossible to pay off the loan during the lockout period, the prepayment penalty and the borrowers must consider the lockout period carefully. No doubt, the lockout period cannot be avoided, so taking out the loan within the lockout period will restrict the future options related to the property, like the sale or refinancing.

  • Fixed Prepayment penalties

Such penalty charges are considered when a commercial loan is paid prior to maturity or within the applicable timeframe during which the penalty can be effective. The fee is typically structured as a percentage of the remaining loan amount.

For instance, if the loan has got a prepayment penalty of 3%, then the borrower would have to pay back the remaining balance plus 3% interest. If you want to pay off the loan in full, a prepayment penalty is based on the leftover loan balance. Thus the penalty will decrease over time.

  •    Step-down prepayment penalties

Such penalties are charged on the percentage of the remaining loan balance like a fixed penalty. But here, rather than maintaining the fee at a percentage for the duration of the penalty, the penalty decreases over time. This means the step-down penalty is scheduled in increments which usually can be 1% for a year.

In some cases, commercial loans might have a soft step-down prepayment structure. It works great for standard step-down Prepayment. The initial percentage can be lower and will decrease at a slower pace. Besides, this type of penalty can actually be advantageous as the person is expected to pay off the loan after a specific amount of time.

  •   Yield maintenance prepayment penalties

It is calculated by solving the present value of the future, and the lender is expecting to collect, Once the loan is carried through the end of the prepayment penalty period. As most of the factors can influence the present value to the future value, the calculation can be quite difficult. This is carried out by the lender, who utilizes yield maintenance frequently.

  •   Defeasance prepayment penalties

Herein, there is a use of government-backed securities to maintain the lender’s identical return rate. The bond coupons help you replace the mortgage as collateral for collecting the interest from the bonds rather than just from the commercial loans.

The treasury bonds herein are used normally because of the predictable nature of the coupon payments. At the same time, defeasance is used primarily with commercial mortgage-backed securities or life insurance company loans. In such situations, defeasance laws or lenders produce identical expected return rates.

Although it is not a typical option, the borrower selects to pay off the mortgage during the defeasance period. As the penalty process can be difficult to understand, there are accountants and other professionals involved in the process.

 

Negotiations for a prepayment penalty

No doubt, commercial loan prepayment penalties can be negotiated. However, to a certain extent, there are different situations in which the borrower will be able to.

  • A shorter duration will significantly reduce the penalty duration
  • Getting a smaller fixed or set down a penalty in exchange for a higher interest rate
  • Get an alternative form of prepayment penalty, which can be economically beneficial and will help save money
  • Give the assurance that the loan is assumable, which means it will allow the transfer of the property without actually paying off the original loan

The prepayment penalty can be negotiated in the proper manner after reviewing the term sheet in detail. Besides, before you sign off any documents, it is essential that you have a clear idea as to how it will work or what you can do to negotiate with the lenders about the prepayment penalties and other aspects.

When you have a clear idea, it will be possible for you to get the deal at a fair rate. When you research well to identify the experts who are there to ensure you have proper support and are capable of getting the loan amount, that will help keep everything under control.

Based on your requirements, you must contact the lender that enables you to save money while ensuring the prepayment penalty is low and the deals are low level.

 

Conclusion

Commercial real estate financing can be quite complicated. There are different aspects one needs to be aware of before borrowing the amount required for financing the property. Having a good idea about it all is the key. You can research well to find the lenders or the experts who can help you understand things well.

To get the assistance, you can contact Private Capital Investor. They are the ones you can trust. They have got expert professionals who understand the market. They will help you find those deals that will work great for you and will allow you to save money during the payment terms. As the best firm in the market, they have got just the proper knowledge and expertise.

For sure, with their professional assistance, you will have a good time getting the loan amount that you need for the financing. Besides, they will also assist you in finding properties that will bring in significant money and help you make a successful investment. So contact them as for sure it would make a tremendous difference.

 

Want to learn more? Get in touch with us today.

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