Losing to Win: When Paying a Prepayment Penalty Makes Sense
Castle Village
July 7, 2014 — Mortgages almost always come with prepayment penalties. Otherwise, borrowers and lenders would both be at the mercy of each others’ whims, borrowers cashing in when rates are low, or lenders demanding repayment when they are high. Sometimes, however, interest rates are so low that the prepayment penalty is very small when compared to future savings. That’s when you want to refinance. Castle Village, for example, made the hard choice and came out ahead.
In 2003, the board of Castle Village, a 550-unit, five-building cooperative in the Hudson Heights neighborhood of upper Manhattan, took out a $25 million, 10-year mortgage that rebuilt the reserve fund and paid for work on elevators, roofs, parapets, terraces, exterior brick walls, and a 75-foot retaining wall. In 2005, a section of that stone retaining wall collapsed.
After rebuilding, Castle Village’s reserves were down to virtually zero, and the co-op had significantly borrowed against its line of credit to pay for an onerous but necessary special assessment. In 2012, the newly elected board examined its financial position: capital needs had been deferred because of the wall collapse and necessary rebuilding. Further, the building’s existing mortgage was coming due in fall 2013. “Luckily for the co-op,” says Andrew Ditton, the treasurer at Castle Village, “interest rates were at historic lows.”
Low Rate vs. Prepayment Penalty
Based on the low interest rates, Castle Village’s deadline-influenced need to refinance and the need for additional capital to replenish reserves and pay for future expenditures, the board decided in spring 2012 to refinance that summer. In late July, when the board was ready to refinance, the commitment issued by the lender NCB was at a record low rate.
It was clearly the best time to refinance, despite the prepayment penalty on the co-op’s existing mortgage. “Weighed against the potential for interest rates to go up, the penalty, which was a little over $100,000, would still be less than an increase of even 50 basis points,” Ditton says. “We looked at the co-op’s needs and at current interest rates. Based on these factors, refinancing in July 2012 made the most sense.”
After refinancing, the co-op had a new mortgage that netted about $11 million and kept the debt service portion of its maintenance payment flat, even after paying off the existing mortgages and making the prepayment penalty, and locked in this financing for 10 years. “The savings were huge,” Ditton observes. “Moreover, interest rates began increasing again, and were much higher the next year, when the board would have originally had to refinance.” Making the right decision at the right time certainly paid off for Castle Village.
For more, see our Site Map or join our Archive >>
Photo by Habitat Staff. Click to enlarge.