Help, which refi option would you choose and why?

[Shaun Carl]

So we are about to Cash-out refi two of our rental properties in a blanket loan. We hold both of these in an S- Corp and have had them for a little over a year. We paid cash for them. All in about 110k total. They are both 4 units. They still need to be appraised, but I am assuming they will appraise for about 150k.

Rates seemed a bit high. Not sure if this is because it will be through the S-Corp and they are commercial. 

Which option would be the best and why?

LTV: 70% of appraised value

Option1: A fixed rate of interest of 5.25% for the first five years. Standard Rate Call Provision to apply to years six through ten.

Option 2: A fixed rate for ten years 6.25%

Term of Loan: 10 years

Amortization: 20 years

Thanks!

[David Oldenburg]

@Shaun Carl I do this every day!  You paid cash for the properties.  If you "cash-out", it is important to look at what you are doing with the cash. I frequently see people cash-out and earn a lower rate of return on the money than what they are paying in interest.  You didn't mention your plans for the money, so I am guessing you have a great investment opportunity. Remember, if the new loan is at say 5.25%, than that is the equivalent of you "earning" 5.25% on that money that is sitting in equity right now.  If you can't earn more than the 5.25% new payment, you would be better leaving the money in equity.

Ok, onto which loan program is best!  Basically, you are comparing 2 loans that are both 20-year amortization, so the best loan is the one that has the overall lowest "cost" when you add closing costs (fees) and total payments. The challenge here is that I am guessing both loans have the same "fees", so the only real difference is the "call option" and the "rate".  It's a no-brainer that the lower rate loan is the better deal. However, it comes with a "call option", which is really a form of an acceleration clause.  The lender is basically saying, "if you are paying us 5.25% and we have a better opportunity, we are going to call your loan due!"  

Here is my advice. The loan amount is small and the difference in payments between the 2 loans is only $63 per month. If you believe you are going to sell or payoff this loan in the first 5 years, you should take the lower rate and take your chance on the later year call option risk. If you are pretty sure you will keep this property more than 5-10 years, the "cost" of the insurance against a call option is an extra $63 per month x 120 months = $7,560.  

There is one other item that is important. What happens at the end of 10 years?  Is there an option to roll into a loan for the remaining 10 years, or do you have to find new financing, pay fees again and start over?  Just something to think about...Good Luck!