What are you going to do when rates go up?
If you are like most commercial real estate owners, you probably haven’t given too much thought to your mortgage rate over the last couple of years. Like many real estate owners today, you probably aren’t even sure what makes up your interest rate? Do you know what your index is? What about the margin? Do you even know where your mortgage agreement is?
If this hits home, you’re not alone. If you’ve got a Prime rate based mortgage, you haven’t seen an interest rate change in almost 6 years. There’s been little need to shop your interest in quite some time.
On Tuesday March 31st, top Federal Reserve policymakers signaled for the first time in years that interest rate increases are on the way. The Feds Jeffrey Lacker warned to expect a .25 percent increase in the Fed Funds rate in June.
That might not seem like a big jump and it’s not. We certainly wouldn’t recommend refinancing a mortgage just for a .25 move in either direction. However, it’s the rising interest rate environment that borrowers should concern themselves with now. Where is your interest rate going to be in the next couple of years? 1…3 percentage points higher?
Let’s take a quick look at interest rate history before the Fed took such drastic measures to lower the cost of borrowing. From 2005 to 2009, the Prime rate hovered anywhere between 5 to 8.25%. During that span, the 10 year Treasury hovered between 2.52% and 4.76%. Certainly much higher than the 1.8% it is trading at today. It’s likely that your mortgage rate is based off of one of these two indicators.
So what is a borrower to do when faced with the rising tide of interest rates? Here’s our suggestions:
- Locate your mortgage agreement and your most recent mortgage statement. Identify what your rate it is, what composes that rate (index + margin = interest rate) and what, if any, restrictions you might have to refinance. For example, perhaps you have a long-term prepayment penalty or are in a swap contract. If you are unsure about anything here, call your CPA, your banker, or even better call us!
- Take stock of what you own and the condition of the real estate. Do you need to make must needed building repairs? Are there any environmental issues you are concerned with? If so, make a quick list of what those are. You also want to get a rough idea on what the building is worth. You can pull assessment records at your local courthouse of your building and those similar to it. Also, visit websites like Zillow or LoopNet for similar property for sale; get an idea what these are selling for. You can even call a realtor and ask them to provide you with a broker price opinion (BPO). They will charge you for this in all likelihood but it’s much cheaper than hiring an appraiser to perform an appraisal
- Get your financials organized. At this point, it’s a good idea to grab the last 3 years of personal and tax returns. If you own your real estate under a separate entity, locate those returns as well along with a recent P&L and any rent roll that might exist. I like to recommend to borrowers to use a service like Dropbox or Google Docs and place all of those documents in a folder there. This way, you can easily shoot these over to a prospective broker or lender.
- The fun part, Rate shopping: Remember, you want to protect yourself from a rising interest rate environment. Therefore, low short term rates are not going to be what you are looking for. Also, you might want to consider a longer term over the lowest rate possible. As a point of reference, we are still currently offering borrowers interest options in the 4% range.
You should also consider what the recession might have done to you or your business. Again, this is another area where you are not alone. Lenders on commercial real estate don’t have the strict credit requirements that their residential counterparts do. Just be prepared to provide a sound explanation when asked by underwriters or loan officers.
We would be glad to assist you with any of these steps above and position your real estate holdings for the rising rates to come. If you would like a free consultation, give us a ring and speak to one of our friendly Commercial Lending Advisors. There’s never any obligation or upfront costs.
You may reach us at 410-420-9741