Dear Norm, The real estate investment company my husband and I own has been doing business with Wells Fargo for more than 20 years without a problem, but we have a big one now. It goes back to three loans we took out in 2006 and 2007. We were looking for fixed-rate loans, using our real estate as collateral, as we had always done. The bank said we could get fixed rates only if we got these things called spurs and swaps. We asked about prepaying. At worst, they said in a presentation, we'd owe an amount "similar to, but generally less than, a prepayment penalty under a traditional fixed-rate loan." Well, as you know, interest rates have declined substantially. But when we went to pay off the old loans to take advantage of the better rates, we learned our prepayment penalties would be 6, 21, and 20 percent of the principal of the respective loans. Altogether, the penalties would come to almost $300,000. That seems outrageous, not to mention that it is the opposite of what we were told when we took out the loans. What can we do? --Debbi Waldenberg, D&D Investments, Kalispell, Montana
Debbi is not alone. Back in the mid-2000s, fixed-rate commercial loans became almost impossible to find. Many banks began insisting that if you wanted a steady, predictable rate, you had to do swaps or spurs, which were complicated financial instruments allowing you to get what resembled a fixed-rate loan but was actually a variable loan tied to another deal with a "swap provider," usually a third party. My company took out a loan during this period, and my banker insisted we do a swap. I didn't understand what it was, even after he tried to explain it to me -- and I'm not sure he did, either -- but it was our only option, and so we agreed.
At the time, a swap looked like a reasonable deal. In any case, it was the only way to get an interest rate that wouldn't vary over the term of the loan. The catch was that if interest rates plummeted, the only way you'd be able to get out early would be by paying a large penalty. Back then, however, almost no one expected interest rates to plummet. Then again, almost no one expected the financial crisis.
But the financial crisis came, and, in an attempt to revive the economy, the Fed decided to keep interest rates extremely low. I suspect thousands of companies are in Debbi's situation. What can she do? Not much. Her least expensive option is to hold on to the loans and make the monthly payments. (We paid off our loan, with substantial penalties, when we sold our business.) Of course, if she feels strongly that the bank has done her wrong and wants revenge, she can find a lawyer willing to launch a class action. The suit might even have a decent chance of succeeding if the bank did not fully apprise her and others of the risks of the loans before insisting they accept the terms of the deal. I wouldn't bother with a lawsuit because I don't think it's worth the time, the money, or the distraction, but it's not my decision. It's Debbi's.
Please send all questions toAskNorm@inc.com. Norm Brodsky is a veteran entrepreneur. His co-author is editor-at-large Bo Burlingham. Their book, The Knack, is now available in paperback under the title Street Smarts: An All-Purpose Tool Kit for Entrepreneurs.