Pick a loan, any loan.

Sometimes you don't know there is a better deal out there.  That is the beauty of choices.  

I recently was looking to get a loan for a self-storage development.  Here were the two options I had:

Option 1:  

10% down

SBA portion of the loan: 5.4% fixed interest rate for 25 years on 40% of the project costs.  Prepayment penalty of decreasing rate from 10% to 1% over the first 10 years of the loan.  Loan is assumable, however.  

Credit Union portion of the loan: 5.5% fixed interest rate of prime rate plus 0.75% once construction is done and loan can be locked in.  25 year amortization with a balloon after 5 years.  Prime + 0.7% after that if another 5 year term can't be negotiated. 6.0% interest only during construction.  No prepayment penalty.  $7800 in closing costs, plus 20 included draws for the title company to pay construction costs - this is probably a $3000 value as they typically cost about $150 each.  

Option 2:

10% down

SBA portion of the loan: 5.4% fixed interest rate for 25 years on 40% of the project costs.  Prepayment penalty of decreasing rate from 10% to 1% over the first 10 years of the loan.  Loan is assumable, however.  

Bank portion of the loan: 5.45% fixed interest rate of prime rate plus 0.7% once construction is done and loan can be locked in.  25 year amortization with a balloon after 5 years.  No additional guarantee of rate or terms after the initial 5 years.   5.45% interest only during construction.  Prepayment penalty for the 5 years decreasing from 5% year one to 1% in year 5.  If an additional 5 year term is negotiated after the initial 5 year term, another prepayment penalty from 5% - 1% will be in effect.  Bank had 0.25% closing cost plus title fees (probably around $8,000) but weren't able to give me any free draws for the construction period.     

Initially, I loved Option 1.  And then I initially loved Option 2 more due to lower interest rate for the construction period and rent-up.  What I didn't like about Option 2 was the lack of perceived flexibility it gave me.  It seemed very restricting with the prepayment penalties without the assumable loan.  I also didn't like the uncertainty of having nothing to fall back on after year 5 when the balloon came due.  No adjustable rate mortgage, no additional 5 year term, nothing.  I felt a little bit naked, so to speak.  In the end Option 2 changed their term to allow for a 5/1 ARM with a prime plus 0.7% rate but wouldn't remove the prepayment penalty after the initial 5 years.  They allowed me to sell the property without penalty, but not refinance.  I struggled with that option although if it were my only option, it probably wouldn't be terrible.  

My philosophy on the overall market and interest rate conditions are this:  I think interest rates are going to go up a little but I think the treasury is going to do a lot of monetary tightening.  What this means to me is that I don't think interest rates will get too inflated but I think free cash will tighten a lot.  That may make it tough for me to get a new loan once mine expires.  Therefore I want some sort of safety net of an ARM for as long as I need to get a new 5 year fixed rate.  If I can't get another 5 year fixed rate due to fiscal tightening by the government and federal reserve, I want to make sure I have a mechanism for keeping the loan going as a safety net.  I could be wrong, but this is my main concern.  BTW, I think this will slightly impede our current economic tailwind (similar to raising interest rates) to keep the economy from getting too inflated too fast.  It might actually stifle growth a bit.  If things are stifled more than a "bit", I want to have protection.  I think I'll be making plenty of rent, but I know interest rates are going to pinch me a little and I don't need the added headache of a big balloon payment I can't get a loan on.  Anyhow, maybe I'm too worried about the downside, but I want to be super conservative in the down direction. 

I asked Option 1 to match the interest rate and reduce the interest-only rate for the construction and rent-up period.  They were able to do that so I was able to go with them.  I really felt confident I'd be able to renegotiate a new 5 year deal that was favorable after the initial 5 year term and if I couldn't, I had the 1 year adjustable rate to fall back on (which the Bank also was willing to do).  The biggest selling point for me was the lack of a prepayment penalty.  If I had to refi for some reason, I would only have to pay the SBA prepayment penalty.  We are talking about having the potential to save $50,000 when I'd probably need the money the most.  Anyway, like I mentioned before, I was thinking of worst-case scenario stuff here and I just felt way more comfortable going this route.  

In the end, both offers were really pretty great but I was able to take a loan that I thought gave me the most flexibility going forward.  Not to mention, very low closing costs once the 5 year initial term wrapped up.