Choosing between 5 Year Loan Rate vs 7 year Loan Rate

[David S.]

Any financial wizards out there?

I am in the midst of refinancing a small apartment building and taking out equity to be deployed in passive syndicated offerings...My lender has offered a fixed 5 year rate and a 7 year rate that is 20bps higher.  The 5 year term will have pre-payment penalties based on 4,3,2,1% (4% in year 1 and 1% in year 4) and the 7 year term will have a 5,4,3,2,and 1% prepayment penalty structure.

I am leaning going to fix rates for 7 years since I am thinking there is a higher probability of rates being higher in 5 years and because I intend to hold the property for a long time and potentially refinance again at maturity. However, at the same time, I have heard lots about the possibility of rates being lower for longer and so I am wondering how I should be looking at it if I were to try and calculate the point of indifference between these two rate terms?

For example, if I were to choose the 5 year fixed rate, should I be calculating what the 2 year rate in 5 years time should be to break even with the 7 year fixed term now being offered?

Or should I be estimating how high another 5 or 7 year term rate can be in five years since I would want to refinance again on a long term basis?

Does anyone have any thoughts on this?

[Erik W.]

A few thoughts....

1) Find a new lender who won't charge you pre-payment penalties and go for the longest lock period you can.  

2) 20 base points is NOTHING. $200 per $1M financed. Spend the extra; limit your risk!

3) Be VERY cautious about borrowing to invest in a syndication.  This suggests to me you have few other investible funds to deploy in case one area/one investment does poorly.  

To do a break even analysis like you're talking--strictly in terms of $$$ and negating the risk of having a note come due 24 months sooner--you simply run out the interest expense for each year over 7 years on both loans (include a refinance of the 5 year for an additional 2 years) and see where your cross the line.  A simple Excel spreadsheet or an online app will show the yearly interest cost as a separate line item.  You'll have to "swag" what you think the future interest rate will be to come up with a break even point.

Btw, I think you may be correct re: higher interest rates in 5 years, but as usual...my crystal ball is murky.  That's why I like to lock in long, fixed rates.  More people have gone broken from not able to service their debt than for any other reason.