A privately held note secured by real property, also referred to as a "hard money" loan or mortgage, is fundamentally no different than a standard bank mortgage. The interest rate is usually higher, but other characteristics – such as monthly payment and insurance requirements – are the same. A property owner can refinance a privately held note just as he could a bank mortgage.
Privately Held Notes
There are two types of privately held property notes. Both are offered by individuals or groups that are not a bank or other type of federally regulated entity. One type of loan is offered by business ventures that seek to earn a relatively high interest on their principal, while also protecting the principal through having it secured by property. These are referred to as hard money lenders. The other is offered by a seller of property to the buyer. He may offer the loan in order to aid in the sale, to avoid an immediate capital gains tax, or to provide himself with monthly income instead of a lump sum at closing.
A prepayment penalty is a fee paid by a borrower to the lender when he pays off a loan during a prepayment penalty period. The penalty period might be any time before the loan comes due, or might be a shorter period -- such as 24 or 36 months from the time the loan was taken out. Some states prohibit prepayment penalties altogether; some limit them to the first two to three years of the loan. Prepayment penalties are often in the range of 2 to 4 percent of the loan balance, but can go higher in states that do not cap limits. Before refinancing a hard money loan -- or any mortgage -- read the existing loan terms to find out whether or not there is a prepayment penalty, and what that penalty would amount to. Then check state law to verify that the penalty in the loan is allowed under state law. A number of states passed new predatory lending laws since 2007 that limit or prohibit prepayment penalties.
Refinancing a hard money note is exactly like refinancing a bank mortgage. Find the refinancing lender and loan, go through a qualifications process, have the property appraised, and give contact information for the original note holder to your new lender so it can make arrangements to pay off the privately held note. The new lender, your lawyer, or a title officer will make sure the note is taken off the property title.
Borrowers often want to refinance out of a privately held note at the earliest opportunity because the interest rate is often quite a bit higher than a comparable bank mortgage. Before rushing to refinance, it is important to weigh the costs of refinancing against the savings you will accrue each month from a reduced monthly mortgage payment. Look for what is called the “break-even point." This is the point in time at which the savings from the reduced mortgage payments amounts to the closing costs for the loan. For instance, if the closing costs are $10,000 and the savings amount on the mortgage payment is $250 a month, the break-even point is 40 months. That is, it takes 40 months of $250 per month in savings to equal the $10,000 closing costs. If you only plan to stay in the house a few more years, it may not make sense to refinance, because the closing costs will be more than the reduction in mortgage payments.
Mary Gallagher runs Mary Gallagher Planning (mgaplanning.com), an urban planning and consulting business in San Francisco. She is the former assistant planning director for San Francisco and planning director for San Mateo. Gallagher has been writing about real estate, development and land use for numerous websites since 1995. She holds a master's degree in historic preservation planning from Cornell University.