Recently I received a couple of questions from a reader who was in a difficult dilemma. This Trustee was faced with the problem of having purchased a property on behalf of the Family Trust a couple of years ago. The property, due to current prevailing economic conditions, had decreased in value.
To make matters worse, the Trustees borrowed money to buy the property and the interest rate on the existing loan was 10.25% p.a. The Trustees wanted to know if they had a legal duty to sell the property.
They also wanted to know if they did decide to keep the property, should they try to refix the existing loan to a new lower loan rate.
I thought I would answer these questions as I think it likely the situation being faced by this particular reader, is being considered by many Trustees in the present time.
We need to remember Trustees have a legal duty to protect capital and assets held by a Trust. This duty has far reaching tentacles. For example, Trustees have a duty to ensure they invest and borrow prudently.
When deciding whether to sell a property held by a Trust, this fundamental duty has to be considered by the Trustees. If there is no risk of foreclosure by the bank and if Trustees can meet the monthly loan repayments, then I believe it would be best to retain the property. I am basing my view on the belief that the property market is not in the best of shapes at present and a sale, whilst being achievable, may not result in the best of sale prices.
On the other hand, if the Trustees cannot afford to meet the loan repayments, then they should take immediate action to either market the property and sell it or look to refinancing the existing loan to a point whether they can afford to meet the loan repayments. Trustees need to do this as one of their main legal duties is to protect the assets of the Trust (eg: the initial deposit put into the property) and losing a property at a mortgagee sale does not demonstrate satisfaction of this duty.
So, whilst Trustees do not have a legal duty to sell a property in a falling property market, they do indeed have a legal duty to weight up the pros and cons of the situation and to make their decision accordingly. Once that decision is made, Resolutions recording the decision should be completed by the Trustees.
On the basis that the Trustees do decide to retain the property, they should then consider if they will stick with the present loan term or will seek to refix the term of the existing loan. Trustees may well want to refix to take advantage of new lower interest rates that are now on offer.
When deciding this question, Trustees must be prudent. This means taking into account a couple of facts such as pre-determining what the cost of refixing the existing loan will be and what quantum of savings will be made as a consequence of moving to the new lower interest loan rate.
One matter to be aware of is that Reserve Bank has slashed the Official Cash Rate from 8.25% mid 2007 to 3.5% as at 29 January 2009. Big deal you say. Why should Trustees care? Because the OCR is one of several factors that influence the interest rates Banks set, which in turn, determines how much Borrowers will repay in loan payments each month.
Will the OCR decrease further? That’s a million dollar question but some of NZ leading Economists think that the OCR could go as low as 2% by the middle of this year. What that may mean is that interest rates could continue to decrease, maybe even reaching low levels such as 5.5% p.a or lower.
We would all be multi millionaires if we knew when the OCR was going to reach rock bottom. I’d probably consider giving up my day job as well if I could predict when interest rates will reach the bottom of the trough as well. Because unfortunately I don’t possess ESP, I believe Trustees should adopt a prudent approach in the current market, and only fix their loans for a short period of time – say 6 months. That way when the bottom of the loan interest rate barrel is in view, Trustees will only have a small amount of break fee costs to pay to the bank when they chose to break the short term fixed rate and move to a long term fixed rate contact.
I’m also an advocate of not being too greedy. According, if a new low interest rate, such as 5.5% p.a. was to come on the horizon, I may well take that up rather than wait for the rate to drop to say 5.3% p.a. As a Trustee I would run the numbers. It may not be worth running the chance that the rate would increase. After all, how much would the savings of say 0.2% really amount to on the loan?
With respect to working out what sort of break fee costs Trustees will pay if they do chose to refix an existing loan to a new lower interest rate, advice should be obtained from the bank. Once this information is to hand, Trustees should compare the quantum of the break fee costs they will have to pay against the savings they will make each month on the loan at the new lower interest rate over the course of the new fixed term.
For example, let us assume Trustees decide to refix an existing original 30 year loan of $500,000 of which has been running for 2 years at an interest rate of 10.25% p.a. which has 3 years left to run, to enjoy a new loan interest rate of 5.99% p.a. Let us further assume that the Trustees decide to lock in this new rate for 5 years.
The old repayments under the loan were $4,531. The new repayments will be $3,072. This means the Trustees are saving $1,459 per month in loan repayments. The break fee costs the bank is going to charge is set at $50,731. So the comparison is against the expected savings over the term and the break fee costs to be charged.
Based purely on this financial criteria only, I’d expect the Trustees to refix as the savings they will make outweigh the costs they will incur. However, it must be remembered that the break fee costs will need to be paid up front. This of course has to be taken into consideration. Once the decision has been made, Trustees should record it in Resolutions.
As to the question whether the bank will try to charge the Trustees break fee costs for breaking the existing loan term, I say check your loan contracts. Most of the contracts I have seen spell out very clearly what the bank is entitled to charge for in the case of an early termination. Solicitors usually go through this particular issue when acting for a borrower as well. Remember, it is a contract that Trustees sign at the time of borrowing funds. Breaking legal contracts have consequences – usually penalties!!!
At present, there is much talk in the media about whether banks will be stopped in their tracks from charging break fee costs. We need to understand a couple of things however in this respect.
All this commentary aside, as a Trustee I would still ask the bank if they would consider wavering or reducing any break fee costs they had decided to charge. After all, you don’t get if you don’t ask. Need more help? Go ahead and Request a Meeting or phone us on +64 9 522 7955.