The Truth About Prepay Penalties
Have you ever wondered why the prepayment penalties are so high when you take out an SBA 504 loan? The 504, as you know, consists of two loans: a first mortgage, funded by a credit union or a bank, typically, at about 50% LTV, and a second mortgage, typically 20 years fixed rate, that is funded by a Certified Development Company, or CDC, for the “junior” 40% of the debt.
The 504 program is great because it enables you to get 90% financing in most cases – lower in some – with a combination first and second mortgage loan on your commercial building, or commercial condo, provided you have 2 years in operation, are “for profit,” and have a net worth for the business of under $15 MM and net profit of $5MM or less per year over the last two yours. In other words, you need to BE a “small business.”
You can refinance your current loan(s) and/or buy a new building or commercial condo.
The SECOND trust deed loan is funded with a debenture, which is a form of a bond. Bond investors need to know their yield is in place for a period of time, so in order to sell the debentures, the SECOND loan, which is actually the SBA 504 guaranteed loan, has a hefty prepayment penalty for the first half of the loan. We’ll talk about this in more detail in future installments.
IF YOU BORROW from a bank or a credit company, chances are you will also have a large prepay penalty on the FIRST mortgage part of the 504. Those penalties are (name your poison):
- The most popular: 5% the first year, 4% the second, 3% the third, 2% the forth, 1% the fifth
- Or you can have 5% flat for 5 years
- 7/6/5/4/3/2/1
- 5% for 6 years then 4/3/2/1
- Here’s one, I call it the rocket prepay: 10/9/8/7/6/5/4/3/2/1
- Or for the truly desperate, 10% a year flat for TEN YEARS
These penalties exist because your lender (the bank, let us say, ) either (a) wants to SELL your loan on Wall Street for a huge premium, or (b) just likes a large prepay penalty.
Now for the good news in this story: Credit unions. Centennial Lending originates loans for our credit union owners. We offer great fixed rate 504 first mortgage loans WITH A ZERO prepay penalty. ZERO, ZED. NADA. You can pay off our loan any time without any penalty. You can pay DOWN our loan and reduce your principal ANY TIME without penalty. We think paying down debt is a good investment for your company, particularly with alternative investments yielding so little. So we do not charge any prepay penalty. Instead, our credit union partners just keep your loan in portfolio instead of selling them to an investment bank. We recycle your money and lend it out again as you prepay. We think it’s good business.
Contact Tim Thomas at 303-746-9169 (tim.thomas@centennial-lending.com) for all the details.