By Marianne Berlan
One of the most significant stewardship responsibilities for a church is managing debt. Churches weigh the decision to incur debt very carefully, and are typically highly focused on the details of the loan. Sadly, once the loan is in place, little thought is given to it. For want of a little attention to current interest rates, churches can miss out on opportunities to refinance debt and free up cash for ministries and missions.
A wise church business administrator will watch the financial markets intermittently to look for opportunities to refinance. He or she will need to know the specifics of the existing loan: what the current interest rate is, what index the rate is tied to, when the interest rate re-sets and when the loan matures. For example, a church may have an “all-in” interest rate at 7 percent, based on the 5-year US Treasury note rate plus a credit margin of 2 percent.
This indicates the 5-year US Treasury rate at the time the loan was obtained was 5 percent. If the 5-year US Treasury note rate is currently 3 percent then a 2 percent savings might be realized. Watching the index will help the church determine whether they should consider refinancing, but there will be other factors to consider.
The business administrator will need a clear understanding of the church’s ministry needs as well. For example, is the church planning on prepaying debt or does the church have an expansion project planned?
Costs may outweigh benefits
If the loan balance is relatively small, and the church is prepaying debt, then there may be no benefit to an early refinance. Closing costs and fees associated with a new loan may consume the savings that might be realized from a lower interest rate. If the church is planning a major expansion project in the near future that will entail additional borrowing, it may be preferable to address the refinance at the same time as the new loan.
The number of lenders that may be willing to provide funds for the upcoming project could be fewer and different from those willing to provide a refinance loan. For example, some lenders have a maximum loan amount that they can provide to any one borrower. Other lenders may have very different underwriting criteria for a construction loan versus a refinance loan.
If refinancing seems to be a good option for the church, then the business administrator will want to estimate what it would cost to refinance. The major expenses typically incurred in refinancing would include title insurance and escrow fees, documentation and legal costs, and appraisal or environmental costs. Most lenders will also assess a loan origination fee. The administrator must investigate whether their current note includes a yield maintenance or prepayment penalty.
Once the administrator has an indication of what the total costs of refinancing may be, he or she can calculate what kind of reduction in interest rate will be needed in order to recoup the costs. Generally speaking, you would want the monthly payment reduction to be sufficient to recoup the costs in less than two years. Most new loan commitments are for at least five years.
Another factor to consider with a refinance loan is what rates and terms are being offered by the lender. The financial markets have been in turmoil for many months now, and all financial institutions are facing an increased cost of funds. Those increased costs are passed on to borrowers by way of higher credit margins and fees.
Consider future rates
While in the example above, the church’s current credit margin is 2 percent, their lender may now offer a credit margin that is significantly higher. Even so, the all-in rate to the borrower may be lower. Further, the church will need to think carefully about where interest rates may be in the future. If the church expects, as many do, that rates will rise significantly in the years to come, then the church may want to refinance now if they can lock in a long term fixed rate at a reasonably attractive level.
As an example, if a church currently has a loan at a fixed rate of 7 percent that matures in two years, and it can refinance that loan to obtain a new 10-year fixed rate loan at 7.25 percent, they may wish to do so. The church may feel they are limiting their exposure to a potentially higher interest rate at maturity. Depending upon the church’s plans for repaying the loan, they may be able to take advantage of more than one pricing option and achieve a lower blended rate.
For example, if the loan is for $4 million and the church plans to prepay $1 million within 2 years, the church may elect to
finance $3 million in a 10-year fixed rate at 7.25 percent and put the other $1 million on an annually adjustable rate at 4 percent. The blended the rate would be 6.44 percent and the risk of a higher interest rate upon the annual adjustment date would be limited to any balance remaining on the $1 million piece of debt.
As always, choose a lender that has a history of lending to churches and one that is financially strong. Be wary of financial institutions that have limited capital to lend or weak fundamentals (such as Tier 1 capital ratios or high loan losses).
Marianne Berlan is vice president for the Church Banking Division of Bank of the West, Walnut Creek, CA. www.bankofthewest.com
HOW ONE CHURCH REFINANCED ITS MORTGAGE
The world is full of risk and today’s economy and credit environment is just making it worse. I am constantly trying to find ways to increase our church’s impact in our community, and at the same time reduce our exposure to potential risk. When the interest rates took a dip this spring, it looked like a great time to investigate a refinance of our existing mortgage at Pikes Peak Christian Church and possibly free up working capital to fund new ministry.
The risk to the church seemed small, the possible fees appropriate, and benefits to the church very promising. But as we looked deeper into the vendors and their requirements, what looked like a slam dunk rapidly became a substantial project with more risk than we originally anticipated. Locking in a reasonable refinance package was like grabbing a handful of oil.
We started our process by issuing a RFQ (Request for Quote) document designed to help us organize the data the vendors delivered and also create a common vocabulary and format for their answers. Our first hurdle popped up when our current mortgage company did not understand the need for a RFQ and thought we were questioning their personal and professional integrity by asking them to complete it. Once we overcame that issue, and smoothed the ruffled feathers, we were able to consolidate the information from all of the vendors into a single summary page that helped us evaluate their products on level ground.
In some ways the preparation process was very similar to a financial review and actually helped us get our ducks in a row in terms of the proper location for key documents and the creation of new financial policies and reporting tools to track data that we will use again. Our stance is that we will always fail on the side of complete disclosure and accountability even up to the stringent requirements of a full Sarbanes-Oxley evaluation.
This philosophy has served us well and actually made us a very strong candidate for the lender’s due to the width and depth of our reporting practices and record keeping.
The final hurdle had to do with internal issues and reconciling two competing thought processes that were held by very committed and passionate groups within our church. One group is very risk adverse and felt strongly that retiring the debt under the current, stable mortgage was the highest priority. The other group understood the benefits of refinancing at a lower interest rate and how the newly freed up capital could be used to fund new or expanded ministry and outreach.
Due to uncertainty in the credit market the best package I could get (at a reasonable rate) was only five years long amortized over 25 years. This scared the risk adverse group to death because of the possibility of a substantial balloon at the five-year break. The other group was not as threatened by the short duration of the loan because we are going to be building in the next two years and the existing mortgage would be rolled into the next building’s mortgage when it launched.
I came up with a compromise that appeased both groups and gained the approval to proceed with the refinance. Our strategy set as a high priority the retirement of the debt through aggressive pre-payment using a portion of the freed up capital created by the new reduced monthly payment. The remainder of the freed up capital would be placed in savings and our Senior Leadership Team was commissioned to create proposals for new or expanded ministry initiatives using those funds.
So where are we at now? Well, not as far as I would like to be at this point, but on the path and plugging along. The lenders are still a little skittish right now and always looking for more assurance, I found out that there is a 1 percent refinance penalty from our old lender, and the interest rates are bouncing around like Lotto balls. Every move forward seems like a baby step and the clock is running on just how much longer the rates are going to stay low enough to make the refinance feasible in the end.
The overall benefits to the church still seem to out-weigh all of the extra efforts and consternation it has caused. We are still committed to moving forward and now we get to include in the conversation pre-qualifying for the new building loan and combined mortgage yet to come.
Just the other day another smaller church approached me and asked if I could help them with their refinance and maybe even approach our selected vendors with a joint request to help drive down the overall costs. Of course my answer was ”yes”, because I think we should always be all about the Big “C” church versus the little “c”. I wonder what would happen if I was able to present them 5,10, or 15 churches worth of pre-qualified business? How would that impact our fee structure and ability to lock-in a good rate? Food for thought maybe?
John C. Mrazek III is executive director of Pikes Peak Christian Church, Colorado Springs, CO. www.yes2god.org