We are considering refinancing our New York City co-op building’s mortgage—what should we keep in mind?
“There are several reasons why your board might want to refinance. The building may need to raise money for capital improvements, the board may want to take advantage of low interest rates or the original loan may be expiring,” says Steven Wagner, a real estate attorney and partner at Wagner, Berkow & Brandt, who represents co-op and condo boards and is the president of his 420-unit co-op.
One of the first areas to address when you are refinancing is whether the building has enough funds for its capital needs. This will determine the size of the loan, Wagner says. “The board must have some idea of the building’s capital needs so it can make sure they get whatever portion of those anticipated needs from the financing,” he says.
If you miss this window to generate funds, the board may be forced to draw on other lines of credit when, for example, the boiler or roof needs replacing.
“That could be very expensive and if there are no capital reserves, you may have to collect assessments, which can be unpopular,” Wagner says.
Establishing capital needs
If you plan on taking out a mortgage with a 10-year refinance agreement—meaning the loan would mature and need to be repaid within 10 years—Wagner recommends getting your building’s architect or engineer to draw up an informal survey outlining the anticipated repairs over the next one-, three-, five-, and 10-year spans.
The reason it is an “informal” draft has to do with tax depreciation schedules, explains Wagner.
“For example, elevators, if they are properly cared for, can run for decades but their depreciation schedule will indicate that they need to be replaced in five, 10, or 15 years, so for accounting purposes it’s best to have a draft version of your capital needs,” he explains, pointing out that very few co-ops or condos include a report on building conditions in their financial statement for this reason.
With that in mind, there are important considerations for this draft report, including the building’s Local Law 97 and Local Law 152 requirements. “These relate to energy and gas pipe examinations, which can be very expensive and should absolutely be included in the report,” he says.
If you’ve prepared a survey of your capital requirements in the past few years, you will want to make sure the lender will accept an update of the existing paperwork, rather than request an entirely new document, Wagner says. “Preparing a new report can be costly and time consuming,” he says.
Keep an eye on timing
The timing of the closing can be important both as it relates to any prepayment penalty you might incur but also the payment schedule for your expiring mortgage.
“There are different strategies lenders use to make sure they are not out of pocket,” Wagner says. Prepayment fees are one of these methods. “You may incur a prepayment penalty or if the loan is expiring there may be a free period for 90 days at the end,” Wagner says.
You also want to avoid having to make an additional payment on your expiring mortgage just because of the timing of the new closing. “For example, some lenders require you to close on the last day of the month and if the closing is delayed the board is responsible for a full additional monthly payment of the old mortgage,” Wagner says.
Negotiating the term sheet
Your lender will provide a term sheet for the mortgage and this is where your attorney plays an important role.
“Some very serious negotiations can take place with respect to the term sheet that will save the building many thousands of dollars,” Wagner says. “For example, if you have five years left on the loan and the lender allows you to prepay without penalty for six months before the loan expires, your attorney can negotiate the prepayment penalty calculation based on four and a half years instead of five. This can save a lot of money,” Wagner says.
The wording you are looking for in your documents is that any prepayment fee calculation be made to the open prepayment date and not the loan maturity date.
Another area of negotiation would be to make sure shareholders are not restricted from transferring the shares of their apartment to a trust or for estate planning purposes. Sometimes lenders set restrictions on what shareholders can do, but an attorney can negotiate more flexibility in this area.
Lenders typically outline requirements for a building’s reserve funds. Ideally, you don’t want them to require reserves for capital repairs costing under $100,000. Also pay attention to whether the lender will waive monthly escrow payments for taxes and insurance. “You may be able to negotiate waiving these costs on the condition there is no default,” Wagner says.
Assignment of the mortgage
Another important consideration is whether your new lender and old lender will agree to an assignment of the existing mortgage. “This can mean savings of hundreds of thousands of dollars on the payment of the mortgage recording tax,” Wagner says.
If you have a $10 million mortgage and you are refinancing for $12 million, an assignment of the $10 million mortgage means you will only pay mortgage recording tax on the additional $2 million. However, Wagner explains, if you pay off the $10 million loan and borrow $12 million without having the old mortgage assigned, you’ll pay a mortgage recording tax on the full $12 million.
“Banks regularly allow this to be done and you can also discuss with them about capping their legal fees,” Wagner says.
Getting the best rate
You obviously want to get the borrowing rate as low as possible.
“Rates are currently at historic lows and the question is, if you are in a position to refinance, how quickly can you do it?” Wagner says.
He points out that “many borrowers use mortgage brokers and some are excellent and can get you significantly better rates than you would by going directly to the lender.”
Recent changes, including the phasing out of the London Inter-Bank Offered Rate (LIBOR), may also require some attention, Wagner says. LIBOR has been the benchmark interest rate at which global banks lend to one another and is being replaced by the Secured Overnight Financing Rate (SOFR).
This variable rate does not affect the mortgage itself once the rate is set, but part of your financing arrangements will likely provide access to a line of credit for emergencies. “The variable rate will affect this line of credit for the duration of your mortgage,” Wagner says.
New York City real estate attorney Steven Wagner is a founding partner of Wagner, Berkow, & Brandt, with more than 30 years of experience representing co-ops, condos, as well as individual owners and shareholders. To submit a question for this column, click here. To arrange a free 15-minute telephone consultation, send Steve an email or call 646-780-7272.