Can Co-op Boards Avoid Prepayment Penalties on Underlying Mortgages?
Sept. 18, 2014 — The whole process of refinancing a co-op's underlying mortgage – fully investigating the issues, getting the best possible terms, and then completing the deal and the associated paperwork — can take almost a year. The worst part? That's under the absolute best circumstances. And it doesn't take into account how much the co-op may have to pay anyway. And the problems start with that matter of prepayment penalties.
Although federal law requires that all individual homeowners — including buyers of co-ops and condos — have the right to prepay their mortgages at any time without penalty, few if any co-ops in the New York area possess that power with regard to their building's underlying mortgage.
Back in the Day
Veteran attorney Arthur Weinstein, who represents dozens of co-op associations and has dealt with scores of refinancings, wistfully acknowledges that he's been in the business of handling negotiations for boards long enough that he remembers the days when mortgages without prepayment penalties could be had.
Moreover, the recent trend has been toward the lender asking boards to agree to mortgages requiring that co-op associations seeking early prepayment pay prepayment fees equal to the greater of 1 percent or a "yield maintenance" amount. This is generally defined as a prepayment premium that allows investors to attain the same yield as if the borrower had made all the scheduled mortgage payments.
The result is that just as interest rates approach historic lows not seen since the early 1960s, co-op boards find themselves stuck with older mortgage loans that require them to pay sometimes quite enormous penalties to refinance.
Why the Change?
One reason for the shift may be a gradual change in the nature of the lending and the players providing it. Stuart Brock, director of mortgage brokerage for Time Equities, notes: "If you look back 20 and 30 years, more of the local co-op lending came from savings and loans, which were offering term loans from their own balance sheet."
By contrast, today's biggest local lenders, like National Cooperative Bank (NCB), are often securitizing the loans, combining and then breaking them up into financial instruments sold to separate parties. Since co-op building mortgages are usually Triple-A rated and failure is rare, the securities markets see them as solid investments. Note that while area banks like Valley National Bank and New York Community Bank continue to offer loans directly from their own portfolios, these tend to be not as competitive as Fannie Mae and Freddie Mac direct lenders or "commercial mortgage-backed securities" (CMBS) products.
Still, You Might Have Options
Savings and loan banks can be competitive, with five- and seven-year co-op underlying mortgages. Standard, though, is the 10-year loan, says mortgage broker David Lipson, who is also director of Century Management's mortgage division, which specializes in underlying mortgages for co-ops.
Thus, while co-op associations cannot prepay their loans as easily as individual borrowers can, they also need not wait 25 or 30 years to pay off their mortgages.
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Adapted from "Solving the Prepayment Puzzle" by Jonathan Leaf (Habitat, September 2014)