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504 Q&A - Refinance & Alternatives to Prepayment

Nov 2007

Q - My customer needs to refinance property subject to a 504 loan. What are the options for avoiding the 504 prepayment penalty?

A - Many lenders are unaware that customers have options that allow them to maintain their 504 loan (with its attractive risk mitigation and fixed-interest rate) and still refinance the first mortgage, which will help the customer, in some cases, significantly lower their monthly payment.

Options:

1. Refinance existing first mortgage (just the outstanding balance) and request subordination by the SBA to the new loan.

2. Refinance existing first mortgage and include new closing costs - this is possible if the loan is seasoned (four years) or has a sufficient collateral value remaining to still support the SBA 504 loan (generally 75% LTV).

3. Refinance existing first mortgage and obtain cash out - note that this is much harder to get approved by the SBA. The loan must be seasoned (funded four or more years), must have a 75% LTV for the SBA 504 loan after the refinance and the cash out, and justification for the use of the cash out funds (must be provided by borrower) that shows the money being utilized to further grow and expand the business. Cash out is typically declined if it is only being utilized by the guarantors for personal reasons and not used for the betterment of the business.

Keep in mind that SBA 504 loans are funded at below market fixed rates and are typically not improved through refinance. Offering to refinance the entire debt can cause a lender to lose the entire transaction because customers in a rate sensitive environment are keenly aware of interest rate risk.

What happens if the customer has to relocate to another facility due to a change in the economy?

The SBA understands that circumstances change constantly for small business owners. Some factors that are the most significant are: rises in interest rates, changes in the valuation of the dollar on the international market, increased local competition, increased global competition, just to name a few.

As a result, if the company is expanding or downsizing and needs to change locations, it is possible for an assumption of the 504 loan to the potential buyer of the property. Note: this option is generally not available for sale of the property solely for a profit. If the business does need a different building, another 504 loan may be an option. Also note that collateral swaps are generally not eligible under the 504 loan structure, though there are exceptions, particularly if justified by the need to downsize or other distress to the business. The 504 loan must stay with the project property either through prepayment or assumption.

For more information, please contact an FFCFC representative at 888.320.5504.

If you have a question you'd like FFCFC 504 experts to answer, email it to insider@ffcfc.com.