In the hybrid part-owner/part-tenant world of co-op living, there exists an interesting and unique financial instrument: the underlying permanent mortgage. Part of the overall financing structure for any co-op, the underlying mortgage (UPM) was conceived as a way to reduce the overall price of entry into co-op ownership. It also serves as a vehicle for tax benefits, and a form of collateral for the community as a whole when cash is needed for repairs and upgrading. Considering the hybrid nature of co-op ownership and administration though, the notion of a 'mortgage' on the whole building can seem a little odd. Is an underlying permanent mortgage more like the mortgage on a multi-unit rental apartment building it's modeled after, or the private home mortgage it also resembles? Should co-ops ‘roll’ the UPM, the way landlords do the mortgages on their rental properties, leveraging their return indefinitely, or should they strive to pay off the debt and proceed debt-free, the way a homeowner would after they pay off their long-term debt? Or perhaps a little of both?
The Typical UPM
Typically, the terms of an underlying permanent mortgage resemble those of a commercial mortgage on a rental apartment building. The loan is usually for a period of 10 years, the interest rate is fixed for that period of time, and the amortization (the repayment of the principal) is based on a longer term – say 20 or 25 years. At the end of the 10-year term, there will still be an outstanding balance, which will require refinancing.
This differs dramatically from typical home mortgages, where the term of the loan and its amortization are matched. That’s known as a self-liquidating mortgage. In other words, a 25-year mortgage is repaid over 25 years. After the final payment, the loan is paid off, period. No refinancing of the note is necessary. That’s not to say there aren’t some self-liquidating underlying permanent mortgages. There are, but they are few and far between.
Typically, the payments of the UPM are split between shareholders as part of their monthly maintenance. Obviously, if a co-op building has no UPM, montly maintenance payments for all shareholders is lower. Lower monthly maintenance is a good thing, overall – but conversely, without the burden of a UPM, the tax deductibility of their maintenance would decline as well. Until the passage of the Tax Cuts and Jobs Act of 2017, higher tax deductibility was viewed favorably. With its provisions limiting the deduction of state and local taxes, the benefits of interest deductions from UPMs has declined.