When a called note cannot refi at today's rates, what is the lender actually holding if it extends

Question

A scenario that is showing up more often. Say a private lender puts $210,000 at 7.2% on a 3/2 in Huntsville, Alabama, two years ago, and the note carries a call provision. The call letter goes out. The borrower tries to refi and the best he finds locally is 8.9% on a 25 year amortization, and at that payment the DSCR comes in at 1.04 against current rent of $1,580. No lender he talks to will go below 1.20. He is stuck, and so is the private lender. The house appraised at $248,000 in March, so there is equity, but equity does not fix a cash flow problem for a lender underwriting to coverage. The borrower asks for an 18 month extension at the same rate with no call provision. The note performs and he has never been late. The trouble is that the original thesis was a 24 month hold with repayment and redeployment, and the lender is already 26 months in, so the clock has slipped once. If rates come down enough for him to refi by month 44, fine. The harder exercise is pricing the scenario where they do not, and deciding what the lender is truly holding in that case. That is the question worth working through here.

cody_ahn · Answer

The part people skip is what "performs now" actually means in month 43 when you've eaten the extension and rates haven't moved. At 8.9% on $210k over 25 years his P&I is roughly $1,740 a month, so at $1,580 rent he's already underwater on coverage without touching taxes and insurance, meaning that 1.04 DSCR his lender quoted is presumably on gross rent, not net, which makes the real number uglier. Huntsville rent growth has been soft in the $1,500 range since mid-2023, a lot of the Madison County inventory that came online stretched that ceiling. If you extend flat at 7.2% you're not just giving up optionality, you're subsidizing his carry while he waits for a macro event neither of you controls. The equity cushion at $248k is real but thin enough that a 6 to 8 percent haircut on a distressed sale eats most of your protection if he can't perform in month 38.

marta_kaminska · Answer

Twenty-six months of performance means nothing if he cannot exit and you are forced to foreclose on a $248k house in Huntsville.

noor_hakim · Answer

That $1,580 rent is the number to pull apart before you sign anything. Huntsville 3/2s in decent condition have been clearing closer to $1,650 to $1,720 over the last six months, based on what current leasing activity in that submarket shows. If his lease is stale and he has not pushed rent to market, that DSCR problem belongs partly to him and only partly to rates. Any extension should carry a rent-reset clause, because agreeing to 18 months at 7.2 percent with no call and rents frozen at 2022 levels is a materially different deal from what you are probably picturing when you say "same rate."

yelena_b · Answer

The scenario where rates don't come down enough is exactly the one to price, because Huntsville rents have been softening in some submarkets since late 2023 and if his $1,580 slides to $1,480 on a lease renewal, his DSCR at 8.9% doesn't come in at 1.04 anymore, it comes in somewhere that makes even you nervous about the asset backing your note. The equity cushion at $248k on a $210k note sounds comfortable until you model a forced sale with 6% commission, back taxes, and whatever deferred maintenance a stressed borrower quietly stopped doing. You're not as protected as the LTV suggests.

I did something similar in 2021, extended a note in Knoxville for 12 months on a borrower who was performing and just needed time to refi. Took no fee, no rate adjustment, nothing. He did eventually refi but it was 19 months, not 12, and I had zero leverage because I'd already agreed in writing to no call provision. If you extend, at minimum reprice the note. He's asking you to absorb his rate risk and your compensation for that is currently zero. Even moving from 7.2% to 7.8% for the extension period and adding a 1% extension fee paid at signing changes the dynamic, not because the money is significant but because it confirms he has some skin in asking for the favor and you have something to show for the extra 18 months of illiquidity you did not plan for.

rbhatia88 · Answer

If he can't refi at 8.9% on a 1.04 DSCR, the math he needs to hit 1.20 at that rate on a 25-year am is probably $1,850 to $1,900 in rent, and whether a Huntsville 3/2 gets there in the next 12 months is really what you're underwriting here. The question I'd want answered before anything else is when his current lease turns over and what comparable units are actually renting for in that zip right now.

ingrid_v · Answer

The exit you're pricing isn't refi risk anymore, it's rent growth risk, because the only path to 1.20 DSCR at 8.9% on that balance is rents somewhere around $1,780 and Huntsville's been moving but not that fast. I had a Decatur note in a similar box and ended up holding 11 extra months while the borrower chased a rate that never came, and I should have charged 8.5% on the extension instead of rolling at the original terms because that's the one lever I actually had. If you say yes, reprice it, 8.5 or 8.75 and a six-month call window starting month 30 of the extension, because "no call provision" is him solving his problem with your flexibility.

natehalloran · Answer

What's the rent growth trajectory in that Huntsville submarket over 18 months?

When a called note cannot refi at today's rates, what is the lender actually holding if it extends

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