Beware the Prepayment Penalty
By: Clifford A. Hockley, President Bluestone and Hockley Real Estate Services, Executive Director, SVN | Bluestone and Hockley
I have been counseling clients for a long time to be careful of prepayment penalties that lurk everywhere in today’s mortgage environment. I don’t like prepayment penalties because they limit your flexibility as an investor (as both Buyer and Seller) in real estate, but they are hard to avoid, and my clients have had many run-ins with prepayment penalties.
Three years ago, I had a client (a Buyer) that was about to close on a transaction when the Seller refused to close. The Seller had not checked on his prepayment penalty, and at the last minute found out it was going to be $250,000. In the end, the Buyer assumed the existing CMBS financing with the Seller paying all assumption costs and agreeing to a price reduction, but it added tension to the deal, and it involved attorneys to sort it out. The Buyer was in a 1031 and had a huge amount of tax penalty at risk.
In a similar situation, another client was recently bitten by the prepayment penalty snake. She refinanced a property, assuming that she was going to hold it for an additional five years. She intended to use the refinance funds to buy another property. Then, out of the blue – just six months after her refinance, another investment opportunity surfaced that needed her to come up with more cash. Her prepayment penalty cost for that small project was $ 45,000 – that’s $45,000 that is no longer available to invest in another project. Using a 6 CAP she lost $750,000 in upside – a significant loss – but she had a better opportunity that needed the balance of the cash.