Cooperatives Refinancing Their Mortgages - Key Issues to Consider Concerning Bank Commitment Letters09/07/2011 | Fall 2011 Newsletter
With interest rates at their current low levels, many cooperatives have been looking into refinancing their existing mortgage, even if it has several years to run and there is still a prepayment penalty to be paid. The reduction in rates may well make it economically beneficial to refinance at this time.
The bank will require the filing of an extensive application, and after some due diligence a proposed commitment letter will be issued.
It is very important to send the commitment letter to your attorney, because it contains many terms that can be harmful to the cooperative, and these terms may be eliminated or modified by negotiation with the bank before the commitment is signed. Once the commitment is signed, the cooperative is locked in. It is very difficult to negotiate the terms of the final mortgage documents once the commitment has been signed.
Some of the more significant issues that the cooperative’s attorney may negotiate include:
- Is the good faith deposit refundable? Many commitments provide that if the loan does not close the bank gets to keep the good faith deposit. This should be changed so that the deposit is refundable unless the cooperative willfully defaults under the commitment.
- Is the cooperative required to escrow real estate tax or other payments with the bank? Commitments typically require such escrows that may also include insurance premiums, and water and sewer charges. This will tie up hundreds of thousands of dollars of operating funds with no interest being paid, and the bank does not escrow them at all — in the event of a default they can be used to pay down the loan if the bank so elects. This obligation may be reduced or eliminated.
- How much of a reserve fund is the cooperative required to maintain at the bank? Banks are now asking that substantial reserve funds be deposited with them — often at low interest rates. The amount of the required deposit and the interest rate may be negotiable.
- Is secondary financing prohibited? This is often the case, and the cooperative needs to either have such financing allowed up to a cap, or have the bank offer such financing on terms to be agreed in the commitment.
- What happens to insurance proceeds in the event of damage to the building? Most mortgage documents provide that use of insurance proceeds in the event of damage to the building is within the discretion of the bank, and the bank has the right to use such proceeds to pay down the loan (and charge a prepayment penalty) instead of using them to repair the building, leaving the cooperative with a damaged building and no insurance proceeds to pay for repairs. The use of these funds needs to be negotiated.
- Is there a limit on contracts that can be signed by the cooperative without the bank’s consent? Often the mortgage documents will prohibit the cooperative from signing any contract in excess of $50,000 without getting consent from the bank. This adds unnecessary time and expense to any repair or Local Law 11 work. The limit on the size the contract that can be signed is negotiable.
- Is the bank’s consent required for amending the terms of the proprietary lease, combining apartments or other alterations, or for entering into any commercial leases or licenses?
There are many other clauses that can be detrimental to the cooperative that can be improved or eliminated by negotiation. The legal fees incurred in negotiating the terms of the commitment are the most important fees in the transaction. While this may add to the overall cost of the closing, it is money well spent.