When Does It Make Sense to Refinance a Commercial Real Estate Loan?

If you own commercial property that you bought with a commercial real estate loan, you might be wondering when and if you should refinance that loan to get a more advantageous interest rate. Refinancing can be beneficial to your business but you’ll need to make sure you understand the process and how it will impact you.

At Addition Financial, we answer commercial real estate questions from our business members all the time. The issue of commercial real estate refinance is one that comes up a lot, so we’ve written this post to help you understand commercial loan refinance, how it works, and when you should pursue it.

What is a Commercial Real Estate Loan?

A commercial real estate loan is a loan that’s granted to a business entity for the purpose of purchasing property for commercial use. Commercial property differs from residential property in that it may not be used for personal purposes. It can be used for an array of commercial purposes, including the following:

  • Office space
  • Retail space
  • Warehousing raw materials or products
  • Recreational space
  • Restaurants

A commercial real estate loan may only be granted to a business entity. Anybody who does business as a sole proprietor would not be eligible for a commercial property loan; however, business entities such as LLCs and corporations can qualify for commercial real estate loans.

What Does It Mean to Refinance Commercial Property?

The process of refinancing commercial property is similar to what you would expect if you decided to refinance a residential mortgage loan. Simply stated, when you refinance commercial property you use a new loan to pay off the balance of an existing loan.

The refinancing process, which we will explain in more detail below, involves completing a new loan application. You will need to provide documentation to support your application. Most people choose to refinance a commercial property loan in the hopes of lowering their monthly payment or using their equity to get cash to pursue their business goals.

commercial real estate vocabulary sheet

When Should You Consider Refinancing Commercial Real Estate?

Refinancing may be the right option for you, but how will you know when it’s time to consider refinancing your commercial real estate loan? Here are some scenarios where refinancing would make sense.

You Want to Lower Your Monthly Payment

The monthly payment for your commercial mortgage is set when you obtain the loan. Assuming that you have a fixed rate loan, you’ll be locked into the same interest rate for the duration of your loan even when interest rates drop.

Refinancing allows you to take advantage of lower interest rates. As a rule, we suggest that a reduction of 2% or more in your interest rate is an indication that refinancing will be worth your while.

You Want More Favorable Loan Terms

Like monthly payment amounts, loan terms are locked in when you sign your loan agreement. In some cases you may be able to get more favorable terms by refinancing.

An example would be if you got an adjustable rate loan. Refinancing might allow you to lock into a lower interest that’s fixed, thus reducing your monthly payments and protecting you against increases in your interest rate when financial conditions change.

You Need Cash to Pursue Your Business Goals

The third reason to consider refinancing your commercial real estate loan is if you want to use the equity in your business property to finance business growth. A cash-out refinance would allow you to use your equity as collateral to get the money you need.

Since most commercial real estate loans have a down payment of 20%, it’s possible to build equity quickly. If you need capital and don’t have another way to get it, refinancing your loan can give you the money to grow your business.

What Are the Pros and Cons of Commercial Real Estate Loan Refinance?

Before you decide to refinance, here are some pros and cons to consider, starting with the pros:

  • Refinancing may help you get a lower monthly payment, which can in turn help you with cash flow to grow your business.
  • You may be able to get more favorable loan terms, particularly if you have an adjustable rate.
  • Cash-out refinancing can help you get the money you need to take advantage of business opportunities and achieve your goals.
  • You might be able to reduce or even avoid making a large balloon payment at the end of your loan term.

These advantages may be enough to convince you to refinance your commercial property loan, but here are a few potential downsides to consider:

  • You’ll need to pay up-front expenses that include closing costs and appraisal fees. You’ll need to crunch the numbers to confirm that you’ll save enough money to make these expenses worthwhile.
  • Your existing loan may carry a prepayment penalty. Such penalties are not uncommon in the world of commercial lending and again, you’ll need to do the math to see if refinancing makes sense.
  • Not all commercial real estate loans can be refinanced. An example is the Small Business Administration (SBA) 504 loan, which is backed by the United States government.

The biggest downside of commercial loan refinance is the up-front costs, including closing costs and prepayment penalties. Closing costs typically range from 3% to 5% of the purchase price, so you’ll need to be sure you have the money needed to pay for these expenses when you close on your new loan.

Which Lenders Will Refinance Commercial Property?

If you have an existing commercial property loan and want to refinance it, there are several options open to you that may enable you to lower your interest rate and monthly payment or borrow against your equity:

  1. The SBA has refinancing options for commercial property loans and you can apply if you meet the qualifications.
  2. The USDA will also refinance commercial loans.
  3. Many credit unions and banks offer refinancing options for commercial properties and businesses.

You may be able to refinance your commercial real estate loan with the same lender who gave you the loan in the first place. For many borrowers, sticking with the same lender is the most comfortable option. However, we suggest shopping around and reviewing your options. For example, in many cases credit unions offer lower interest rates than banks, so if your loan is with a bank you may want to consider a credit union.

What is the Process to Refinance a Commercial Property Loan?

The process of refinancing a commercial property loan is a lot like the process of refinancing a residential loan. Here are the steps you’ll need to take:

  1. Prepare the necessary documents. Just as you did when you obtained your existing loan, you’ll need to present financial documents that demonstrate the health of your business. These may include:
    1. Two years of business tax returns
    2. Two years of business bank statements
    3. Two years of profit and loss statements
    4. Two years of financial statements
    5. Business plan (not required by all lenders)
    6. Executive summary (not required by all lenders)
    7. Personal financial documents (if you are signing a personal guarantee or expect to be asked to sign one.)
  2. Research lenders. As we mentioned above, it’s essential to take the time to research prospective lenders. You’ll need to understand which lenders offer the most advantageous terms and rates and you may also want to look at support and other services.
  3. Apply for refinancing. Keep in mind that commercial lenders are going to look at multiple ratios to determine whether your business can pay for the refinance loan. These may include the following.
    1. Debt-to-loan ratio, which compares the amount of your loan to the value of the property being refinanced. You’ll need a ratio of 80% or less to qualify.
    2. Debt ratio, which measures the ability of your business to generate enough income to pay your loan.
    3. Debt service coverage ratio, which is used to determine if the property being refinanced generates enough income to pay for the monthly debt service.
  4. Provide additional information as needed. During the underwriting process, the lender will review your financial documents, calculate ratios, and order a property appraisal. They may come back to you requesting clarification of the information you provided or asking for additional information. You should respond promptly to avoid delays.
  5. Loan approval or denial. After the underwriting is completed, you will receive a response from the lender either offering you a loan or denying the loan.
  6. Closing. The final step is the same as it would be with any other loan. You must attend a closing, pay all closing costs and related expenses, and sign the loan documents. After the loan documents have been signed, the money from your new loan will be used to pay the balance of your old loan. If you are doing a cash-out refinance, the closing is also when the money you are pulling out of your property will be transferred to you.

The process isn’t any more complicated than the process for a residential mortgage refinance. If you have your documentation in place and the financial means to make your monthly payment, there’s a good chance that your commercial loan refinance will be approved.

If you have a commercial real estate loan, refinancing can be a good way to get a more advantageous interest rate or reduce your monthly payment. The key is to have your financial documents in order to streamline the underwriting process and increase your chances of approval.

Do you need assistance with commercial property loan refinance – or financing your business in general? Addition Financial is here to help! Click here to read about our business loans and apply today.

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