Something every borrower should consider is how loan rates can change over time. A real estate loan can come at a fixed or a variable rate. A fixed rate loan remains at the initial interest rate over the entire course of the loan. Borrowers will make the same payment every month over a given period. Few borrowers can qualify for a fixed rate commercial loan.
Variable rate loans are more common when it comes to commercial real estate. The interest payments on variable rate loans can change over the course of the loan. Any increase or decrease in interest is usually tied to the prime (or market) rate. Prime rates generally change every 1 to 5 years and many variable rate loans are offered as the prime rate plus a certain percentage of interest. For example, if the current prime rate is 4 percent, a bank could offer a loan as prime plus 3.5 percent so the initial interest on the loan will be 7.5 percent. However the interest on this loan will fluctuate and will rise or fall according to the prime rate.
Interest rates are not the only thing borrowers should be aware of, as the structure of a commercial loan is equally important. Some loans are fully amortizing which means that the interest payments and the principle of the loan are fully paid off once the loan expires. Some loans are also structured with variable rates that reset after a given period. Like any variable rate loan you pay a given interest rate for an initial period. After this initial period the interest rate will reset and the borrower will pay at the new rate until the next reset period or until the loan matures. However balloon payment type loans account for the majority of commercial mortgages. In technical terms balloon loans have longer terms than their amortization periods. This means a certain amount of interest and principle will need to be paid off once the loan expires. Borrowers with this type of loan will need to plan ahead and calculate what the balloon payment will be when the loan matures, or make plans to refinance ahead of time. With a balloon loan an unprepared borrower could easily default.
Government backed loans and conventional bank loans usually offer the lowest interest rates. SBA 504 and 7a loans offer the lowest interest rates overall. The government guarantees a certain percentage of these loans and the risk for the mortgage provider is alleviated, which results in lower interest rates. 7a loans are easier to qualify for and are usually for smaller amounts than 504 loans. The interest on a 7a loan can be variable, but usually ranges from 6.5 to 9 percent. SBA 504 loans are intended for loans over one million dollars and are usually issued in “stacks.” 50 percent of the loan comes from the bank, 40 percent from an SBA provider and 10 percent of the loan is the borrowers down payment. The bank issued portion on a 504 loan is usually variable while the SBA backed portion being offered at a fixed rate. The average rate on a 504 loan currently ranges between 3.96-4.43 percent, making 504 loans the cheapest type of commercial loan. Banks also offer conventional loans that are not backed by the government. Borrowers seeking a commercial loan from a conventional bank should have a good credit profile, expect to pay a higher variable rate over an SBA loan and have at least a 20 percent down payment on hand. However some borrowers may not qualify for a low rate SBA or a conventional bank loan
Hard money lenders usually charge the highest interest rate when compared to other commercial mortgage providers. The average interest on a hard money loan is usually 10 to 18 percent. These high rates reflect the additional risk involved with hard money lending. Hard money lenders consider the value of the asset being borrowed against over a borrower’s credit profile. Hard money loans are generally short term, with repayment schedules averaging between 6 and 12 months. In spite of their expense a hard money loan may be a good option for commercial real estate investors without a good credit profile and who need a “bridge loan” to more conventional financing.
Borrowers should know whether their loan is fixed rate or variable and whether their loan is fully amortized. A borrower’s credit score will determine whether they qualify for a lower rate SBA or conventional bank loan, or whether they should seek out a hard money lender.
Level 4 Funding LLC Private Hard Money Lender
Arizona Tel: (623) 582-4444
Texas Tel: (512) 516-1177
Dennis@level4funding.com NMLS 1057378 | AZMB 0923961 | MLO 1057378
22601 N 19th Ave Suite 112 | Phoenix | AZ | 85027
111 Congress Ave |Austin | Texas | 78701
About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 42 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.