Greetings BP Friends!
Hope you all enjoyed the long weekend.
Here is the situation:
I have always used traditional fixed 15-30 year financing in the past. This is the first time I was evaluating a balloon mortgage scenario.
However, since my rate was high I thought refinancing at a lower rate as it would increase my cash flow in the short term that would allow me to invest some of the proceeds to fund future deals.
Concern:
Having never been through the balloon mortgage scenario:
The mortgage rep was positive that if all things equal I should have no issues re-financing at the market rates and still keep the property.
I want to get guidance from fellow seasoned investors if I should stick with what I have now or go for the balloon mortgage scenario?
Thanks in advance for reading the post and your continued guidance and support.
I'm pretty much against all "Balloons".
Nobody knows what interest rates will be in 5 years, but there is an indication with the Q E of $85 billion a month that the interest rates will be higher at some time in the future. It is possible that the interest rate in 5 years could be higher than your current 6.75%
Most people don't remember but in 1981 and 1982 mortgage interest rates were 15% to 18% or so fixed for 30 years. Figure out what that did to mortgage payments, and new mortgage lent.
All the time :-)
All mortgages in Canada are essentially "balloon" loans as mortgage terms here vary from 0.5 - 10 years with 5-years being the most common (on both residential and commercial).
Since we know we'll be renewing every 5-years, or primary concerns at the time we are (re)negotiating our financing are rate and flexibility of payment (ie. no prepayment penalties or large pre-payment allowance). It is for this reason all our current residential mortgages are variable {what you like to call adjustable} rate (2.6%) rather than fixed (4 - 5.34%) ... interest rates would have to climb over 2% before there would be any chance of the fixed rate mortgage out-performing the variable. Additionally, the variable rate products we are using all have either a cap or right of conversion into a fixed rate mortgage ... so if rates were to start a steep upwards ascent, we can limit our exposure.
A five-year term has the advantage that you get to shop around your mortgage every five years and have the lenders compete for your business ... this has resulted in our being able to secure up to 0.5% off prime on our mortgages.
I'm pretty much against all "Balloons".
Nobody knows what interest rates will be in 5 years, but there is an indication with the Q E of $85 billion a month that the interest rates will be higher at some time in the future. It is possible that the interest rate in 5 years could be higher than your current 6.75%
Most people don't remember but in 1981 and 1982 mortgage interest rates were 15% to 18% or so fixed for 30 years. Figure out what that did to mortgage payments, and new mortgage lent.
I'm a big believer that the type of financing you have on a property should generally match your investment goals. If this is a long term buy and hold, then it should have long term, stable financing. If you were planning on dumping the property in the next five years, then a balloon would be fine. I gotta agree with @David Krulac that no one knows what lending conditions or property values will be like 5 years from now, and it's a risk that I wouldn't want to take on for my long term portfolio.
I'm currently in the process of doing the exact same thing, but my 15yr fixed rate is obscene (8%).
This property was a pretty beat up foreclosure and the bank holding it offered the financing, 15% down and 8% fixed. I just finished rehabbing it and we will be 100% occupied (6units) on Dec 13th
The refi has almost tripled my COC return and even projecting 2% increases every 5 years it still keeps my COC over 20% till payoff.
Being a veteran of the 19% mtg era & based on the limited information you posted, I would stay with the 15 yr term as interest rates can only go up.
The balanced owed is not revealed so the 2.25% difference may not be as big an issue given the additional closing costs (x2) over the 5yr period. Furthermore, you do not reveal the term on the 5yr balloon. If it's 30 yrs you would definitely relieve some cash flow pressure (depending on what's owed), if that's an underlying issue.
However, whenever new financing begins the % principal applied takes a hit & no matter how slight it still adds up on long term B&H.
My strategy (living with the higher int rates) was to just pay down the principal faster & very quickly everything we owned became free & clear :)
@Azeez K. Interesting scenario. There's a few things to evaluate to help make up your decision. How long have you had the existing financing on the property? Are there any prepayment penalties? What is the current cap rate? What is your loan to value? Will you be taking any cash out or is this rate and term? Depending on your investment needs will help determine the best route for you. There could be some other loan programs available to better suite what you are looking to accomplish.
I missed the 19%, but our first mortgage was at 16.8 - a tough five years, but is is what got me looking into variable rate mortgages.
There was a historical study of mortgage rates in the Canadian market from post WWII until the late 1990s which demonstrated that if you took any 25-year period [the most common amortization in Canada] and compared 5-year term variable and fixed rate mortgages within the 5 decades of the study the borrower always came out ahead going with the variable rate.
Now, with 15 & 30yr terms available in the U.S., I expect there would be times when locking into a fixed-rate long-term mortgage would have been advantageous, but I would expect there would have been as many or more times when it would have not been advantageous.
@Azeez K. A few questions popped up from your post:
1. If the 6.45% 15yr loan worked in the investment plan for the property when it was acquired, what has changed that makes the plan worth changing?
2. Only by running the numbers completely will the cost/benefits of refinancing vs. staying with the current financing over the next five years become clear. That includes the differences in amortization as well.
3. One other thing to include in the analysis is that you may end up paying for three or more sets of loan fees and costs by going to the shorter term, good for the bank but make sure to include those in the calculation.
4. The last one is where will the property be in the market cycle in five years? How likely is it to be a period where refinancing is expensive or non-existent? Given that if financing were hard to get, selling at a decent price might also be hard to do, what would your strategy be?
Good hunting-
Firstly, my sincerest thanks to you guys for providing guidance, support and taking time from your busy schedules to respond to my question:
Initially, I was not thinking about the cost of re-financing at the end of the 5 year term so you bringing up the cost certainly helps me put that into my calculation.
@Roy N.
Thanks again your response gives me comfort and my key takeaway is to follow-up with my mortgage person to see if the rate they are quoting have either a cap or right of conversion into a fixed rate mortgage.
@David Krulac
Thanks for your input. I have a follow-up question for you since you mentioned you were against all balloons how do you get commercial financing for your property w/o Mortgage Balloon scenario. I have had a tough time finding traditional community banks/lenders that offer fixed rate commercial loans. The only way I was able to get a fixed commercial loan the first time around was because it was my first Small Business loan..all other banks have indicated that they only do balloons 5 or 7 year balloons. Any guidance?
@John Chapman
You bring up a great point that type financing should match investment goals. I have decided to take the advice and continue to keep this as fixed loan since it's part of my long term portfolio so many thanks.
@Mat Lewczenko Kudos for getting the foreclosure deal with the bank and increasing your COC return. Happiness is positive cash flow - :-) Fred Adler
@Pat L. - Point noted thanks for your insight.
@Vangie Gal - I have had existing financing on the property for 1 year. No pre-payment penalties, Cap rate is 11.5%, LTV is 77%, Planning on taking some portion of the cash for purchase of a new MF (as opportunity presents)
@Giovanni Isaksen -
6.75% rate worked in the investment plan to begin with. What has changed - The desire to grow and increase the portfolio of properties quicker as such wanted to raise more capital by refinancing plus using seed money to purchase a 2nd, 3rd etc..
Agree - ran some preliminary numbers it makes sense to refinance. However, accounting for uncertainties and cost to finance the property at the end of 5 years it seems being on fixed rate would make sense. To be honest, I have not accounted for your last bullet in terms of my strategy and will have to give it more thought.
Again thanks to you all for your guidance and feedback. I have learned a lot from your collective experiences.
Firstly, my sincerest thanks to you guys for providing guidance, support and taking time from your busy schedules to respond to my question:
Initially, I was not thinking about the cost of re-financing at the end of the 5 year term so you bringing up the cost certainly helps me put that into my calculation.
Thanks again your response gives me comfort and my key takeaway is to follow-up with my mortgage person to see if the rate they are quoting have either a cap or right of conversion into a fixed rate mortgage.
Thanks for your input. I have a follow-up question for you since you mentioned you were against all balloons how do you get commercial financing for your property w/o Mortgage Balloon scenario. I have had a tough time finding traditional community banks/lenders that offer fixed rate commercial loans. The only way I was able to get a fixed commercial loan the first time around was because it was my first Small Business loan..all other banks have indicated that they only do balloons 5 or 7 year balloons. Any guidance?
You bring up a great point that type financing should match investment goals. I have decided to take the advice and continue to keep this as fixed loan since it's part of my long term portfolio so many thanks.
@Mat Lewczenko Kudos for getting the foreclosure deal with the bank and increasing your COC return. Happiness is positive cash flow - :-) Fred Adler
@Pat L. - Point noted thanks for your insight.
@Vangie Gal - I have had existing financing on the property for 1 year. No pre-payment penalties, Cap rate is 11.5%, LTV is 77%, Planning on taking some portion of the cash for purchase of a new MF (as opportunity presents)
6.75% rate worked in the investment plan to begin with. What has changed - The desire to grow and increase the portfolio of properties quicker as such wanted to raise more capital by refinancing plus using seed money to purchase a 2nd, 3rd etc..
Agree - ran some preliminary numbers it makes sense to refinance. However, accounting for uncertainties and cost to finance the property at the end of 5 years it seems being on fixed rate would make sense. To be honest, I have not accounted for your last bullet in terms of my strategy and will have to give it more thought.
Again thanks to you all for your guidance and feedback. I have learned a lot from your collective experiences.
There have been a couple of occasions where I did get a mortgage that was fixed for 5 years, then adjustable thereafter, but no balloon.
I first look, when getting a mortgage, for residential bank mortgages for SFH, and multi-units up to 4 units. I'll go to the FNMA limit on number of mortgages, then have my wife go to the FNMA limit. Then go after portfolio mortgages (non-FNMA). Then I'll also go after some seller financing. And then we also self finance. I've had good success dealing with brick and mortar local/regional banks and credit unions.
In one case I was dealing with a seller, who was also a broker. He wanted a 3 year balloon. We negotiated and ended up with a 15 year self amortizing mortgage with no balloon.