Commercial Mortgage Refinancing: How Does It Work?

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Whether you’re a small business owner who owns their own building or a commercial real estate investor, there may come a time when you’ll want to think about refinancing your mortgage. Perhaps you want to lower your interest rate, change the loan term or get cash out of your equity to finance renovation or repair costs.

If you are considering commercial mortgage refinancing, you’ll want to understand how it works to ensure you maximize the benefits for you and your business.

Why refinance a commercial property mortgage?

Reasons to refinance a commercial property mortgage include:

Lower interest rate: Although interest rates are rising, they’re still low by historical standards. Refinancing could get you a lower interest rate than what you are currently paying.

Lower monthly payment: A reduction in your interest rate, even if it is just .05%, can result in a decrease in your monthly payment. This can improve your all-important cash flow.

Get cash for property improvements: You may choose to get a cash-out refinance, in which you’ll borrow against your existing equity to get a lump sum that you can use for repairs or renovations.

Favorable loan terms: You may want to switch from an adjustable-rate mortgage to a fixed-rate loan, which offers stability. Or perhaps you want to change the length of your term. Extending your loan term will give you more time to pay off the mortgage and lower your monthly payment. On the other hand, getting a shorter loan term could reduce your overall interest costs, saving you tens of thousands of dollars, if not more, in the long run.

Avoiding balloon payments: Refinancing your mortgage before a balloon payment becomes due can allow you to get a fully amortized loan without one large payment at the end of the loan term.

Eligibility for a commercial mortgage refinance

Your lender didn’t just hand over the cash when you applied for your commercial property mortgage. They had to make sure that lending you money wasn’t unduly risky, and they used their loan requirements to determine this.

When you are refinancing, the requirements are similar to those for your original loan. Major loan requirements you will face when refinancing include:

  • Personal credit score: Lenders want to know you are someone who’s responsible with your finances and pay off debts. Your credit score will give them better insight into your ability to manage debt, credit and more.
  • Business credit score: Each business has a credit score. Dun & Bradstreet, Experian and FICO are the three most widely used agencies that produce business credit scores. Similar to your personal credit score, your business score may be evaluated to help lenders determine if you are likely to repay your loan.

    This score, which will range from 0 to 100 (Dun & Bradstreet and Experian) or 0 to 300 (FICO), is calculated using your company size, industry risk, credit utilization ratio, current debts, repayment history, length of credit history and public records.

  • Repayment ability: Lenders want to see that you can repay the loan. The most common metric they use for this is your Debt Service Coverage Ratio (DSCR), which is calculated by dividing your business’s net operating income by your annual loan repayments. You’ll want a ratio of 1.2 or higher.
  • How long you’ve owned the property: Lenders may require you to have owned the property for a certain amount of time before they’ll agree to approve you for refinancing.

Commercial refinance vs. home loan refinance

The concept of refinancing is similar for both a commercial refinance and a home loan refinance. With either option, you are creating a new loan to repay the original loan, but they are still different in many ways.

The key differences between a commercial refinance and a home loan refinance include:

  • Amortization: Amortization, which is the gradual reduction of a debt that happens when you make payments on the loan, has different periods for home loans and commercial loans. While a homeowner will likely have their full loan balance paid off by the end of the term, business owners may find that they still have a large balloon amount to pay off when the final payment is due.
  • Loan requirements: As we explained above, when you refinance a commercial loan, lenders will examine more than just your personal credit score and monthly income, which are often key factors in determining a homebuyer’s approval for a home loan refinance. In a commercial refinance, the lender will examine your business’s credit score, net operating income and other factors that are not necessary for a home refinance.

Commercial refinance loan types

There are several kinds of commercial refinance loans available to business owners. These include:

Small Business Administration refinance loans

The Small Business Administration is a government agency that assists people with starting their businesses and then running and growing them. The SBA offers two commercial refinance loans with a $5 million loan maximum: SBA 7(a) and CDC/SBA 504.

SBA 7(a) loan: The SBA backs as much as 85% of this loan if it’s for $150,000 or less, and up to 75% if it’s for more than $150,000.

SBA 504: The SBA backs as much as 40% of this loan, while a Certified Development Company (CDC) backs as much as 50% of the loan. The borrower backs the remainder of the loan in the form of a down payment.

Commercial bank refinance loans

Most large commercial banks operating within the United States offer commercial refinance loans. You can opt for a traditional commercial refinance, but it is possible that the bank you choose as your lender will have additional refinance products available. For example, commercial bank refinance products also tend to include a cash-out option that allows you to take advantage of the property’s equity and use the money for various business expenses and projects.

Credit union refinance loans

Credit unions may be smaller than banks, but they are still able to offer commercial real estate and commercial refinance loans to members. This option may appeal to many business owners because credit unions are known to offer low interest rates on their loans. Keep in mind, though, that the maximum loan amount may be less than what a bank or other type of lender can offer.

Finding a lender

Finding a lender to refinance your current commercial loan can be just as easy as finding a lender for a home loan refinance. You’ll probably have the best luck with your current lender, but you may want to shop around to find the best deal. If you’re going for an SBA loan, you can use the SBA’s free lender match tool. It’s also helpful to network with other commercial property owners to find out who they recommend.

Steps to refinancing your commercial mortgage

The commercial mortgage refinance process will include many steps, which we’ll walk you through here.

  1. Lender selection: Choosing a lender is an important step because this determines what refinance products are available to you, how much you can borrow and more. Depending on your needs, some lenders will be more suitable than others.
  2. Application submission: When you select a lender, you will have to fill out and submit an application for your commercial refinance. The lender may request various documentation, such as proof of income, rent roll and financial statements.
  3. Underwriting: Once the application and the necessary documentation have been submitted, the lender’s underwriting department reviews and verifies the information you provided. It is likely that they will appraise your property and review reports during this time.
  4. Approval/denial: After your application and documentation have been reviewed, the lender will either approve or deny your loan. If you’re denied, you can try approaching another lender. If your loan is approved, you can move forward to the last step of the process.
  5. Closing: This is where you pay closing costs, sign documents and receive final paperwork. If everything looks good, you’ll get the funds you need.

Fees and closing costs

Fees will vary by lender, and no two lenders are alike. However, there are common fees that you can expect to pay when refinancing your commercial mortgage.

  • Prepayment penalties: Your current lender may charge you a hefty fee for paying off your mortgage early.
  • Guaranty fee: The SBA charges this fee to lenders for having the government back your loan. Lenders pass the fee on to borrowers. You’ll pay this upfront and annually, but only on the amount of the loan that the SBA is backing.
  • Credit report: Lenders pay to access information about your credit history, and they pass the cost on to you.
  • Origination: Lenders charge this to cover the cost of originating the loan, which includes processing, underwriting and funding the loan. Depending on the lender, it will be a percentage of the loan or a flat fee.
  • Appraisal: You’ll need to pay for an appraiser to estimate the value of the property you plan to refinance.

Summary

As a business owner, you have a lot of tough decisions to make, and each one has the potential to harm your business. Choosing to refinance your commercial real estate loan can do more good than bad, which is why many borrowers choose to refinance. If a lower monthly payment and money in your pocket is the goal, commercial mortgage refinancing could be the answer.

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