Help, which refi option would you choose and why?

Question

So we are about to Cash-out refi two of our rental properties in a blanket loan. We hold both of these in an S- Corp and have had them for a little over a year. We paid cash for them. All in about 110k total. They are both 4 units. They still need to be appraised, but I am assuming they will appraise for about 150k.

Rates seemed a bit high. Not sure if this is because it will be through the S-Corp and they are commercial.

Which option would be the best and why?

LTV: 70% of appraised value

Option1: A fixed rate of interest of 5.25% for the first five years. Standard Rate Call Provision to apply to years six through ten.

Option 2: A fixed rate for ten years 6.25%

Term of Loan: 10 years

Amortization: 20 years

Thanks!

Shaun Carl · Answer

Wow, Thanks @David Oldenburg !

Yeah we wouldn't be pulling out the cash if we didn't have a better return in the works.

We are looking to possibly buy another property and then use the rest for some low end flips or just focus on flipping for a bit to build some cash reserves. We have someone that usually would take these deals but is strapped for cash because of a huge deal he is in the middle of and we would like to take these for some quick cash. He usually generates ~40% return on these at about 1 every 1-2 months.

The bank mentioned that the 10 year term/20 year amort. would have the lower monthly payment. He usually would offer only a 15 yr depending on the amount, but wanted to preserve as much cash flow as possible for us. The 5 year must not be set for 20 year amort. then.

At the end of the 10 years, the bank said we could look to refi again if needed.

He seems to want to help us grow and be profitable. Thanks for helping to explain.

David Oldenburg · Answer

@Shaun Carl I do this every day!  You paid cash for the properties.  If you "cash-out", it is important to look at what you are doing with the cash. I frequently see people cash-out and earn a lower rate of return on the money than what they are paying in interest.  You didn't mention your plans for the money, so I am guessing you have a great investment opportunity. Remember, if the new loan is at say 5.25%, than that is the equivalent of you "earning" 5.25% on that money that is sitting in equity right now.  If you can't earn more than the 5.25% new payment, you would be better leaving the money in equity.

Ok, onto which loan program is best!  Basically, you are comparing 2 loans that are both 20-year amortization, so the best loan is the one that has the overall lowest "cost" when you add closing costs (fees) and total payments. The challenge here is that I am guessing both loans have the same "fees", so the only real difference is the "call option" and the "rate".  It's a no-brainer that the lower rate loan is the better deal. However, it comes with a "call option", which is really a form of an acceleration clause.  The lender is basically saying, "if you are paying us 5.25% and we have a better opportunity, we are going to call your loan due!"

Here is my advice. The loan amount is small and the difference in payments between the 2 loans is only $63 per month. If you believe you are going to sell or payoff this loan in the first 5 years, you should take the lower rate and take your chance on the later year call option risk. If you are pretty sure you will keep this property more than 5-10 years, the "cost" of the insurance against a call option is an extra $63 per month x 120 months = $7,560.

There is one other item that is important. What happens at the end of 10 years?  Is there an option to roll into a loan for the remaining 10 years, or do you have to find new financing, pay fees again and start over?  Just something to think about...Good Luck!

David Oldenburg · Answer

@Shaun Carl Your welcome!  I hope it all works out for you :-)