Commercial real estate loans are usually used to buy, refinance, or rehabilitate commercial, industrial, and other non-owner-occupied properties. These include hotels, office buildings, warehouses, medical facilities, multi-unit rental buildings, and land where you can build these kinds of property. Lenders usually underwrite commercial loans based on the expenses and the income that a property will generate.
Commercial real estate loans are an essential tool for investors looking to purchase or improve income-generating property However, in order to ensure you get the best deal, you need to understand what goes into determining your interest rate This comprehensive guide will walk you through the major elements that influence commercial mortgage rates so you can make an informed financing decision.
What is a Commercial Loan Rate?
The commercial loan rate refers to the annual percentage rate (APR) lenders will charge you to borrow money to invest in commercial real estate This rate is expressed as a percentage of the principal loan amount.
For example, if you take out a $1 million loan at 5% interest you would pay $50000 in interest charges for the first year of the loan. The principal loan amount is the amount you actually borrow, while the interest rate determines the additional cost of borrowing money.
Commercial loans typically have higher interest rates than residential loans to account for the increased risk lenders take on with business properties. However, investors can still find competitive rates by shopping around and improving their credit profile.
Key Factors That Influence Commercial Mortgage Rates
Many elements go into determining the interest rate a lender will offer on a commercial loan. While specific formulas vary, these are some of the most important factors:
1. The Federal Funds Rate
The Federal Reserve uses the federal funds rate to control economic growth and inflation. This rate essentially sets the floor for commercial loan rates, as lenders will add to it based on market conditions and the specific loan. As of March 2023, the federal funds rate range is 5.25% to 5.5%.
2. The Prime Rate
The prime rate is the interest rate banks extend to their most creditworthy customers. It serves as a benchmark for commercial loan rates. For example, while the prime rate may currently be 8.5%, lenders may offer their best commercial borrowers rates starting at 8.5% but extend higher rates to riskier borrowers.
3. Treasury Yields
The yields on 5-, 7-, and 10-year US Treasury notes influence lending rates economy-wide. If Treasury yields rise, it indicates higher rates for borrowers as well.
4. Credit Score
Your personal or business credit score greatly sways what rate lenders will extend to you. In most cases, applicants need at least a 660 FICO score to qualify for commercial financing. Above 740 is considered excellent. The higher your credit score, the better interest rate you can expect to receive.
5. Debt-to-Income Ratio
Your debt-to-income (DTI) ratio compares your total monthly debt payments to your gross monthly income. The lower your DTI, the more likely lenders are to approve your application and offer better rates. A DTI below 50% is ideal.
6. Loan-to-Value Ratio
The loan-to-value (LTV) ratio compares the size of your loan to the appraised value of the property. Putting down a larger down payment reduces the LTV, making you look like less of a risk to lenders. Typical commercial LTVs fall between 70% and 80%.
7. Property Type
Certain commercial property types like hospitality and retail are viewed as riskier bets than others such as industrial and multi-family. Expect to pay a slightly higher interest rate for properties with higher vacancy rates and operating expenses.
8. Location
Interest rates can fluctuate based on the location of your commercial property as local market conditions influence risk factors. For example, financing a property in a depressed area may mean paying more in interest than for a comparable building in a thriving real estate market.
9. Loan Term
In general, longer loan terms equate to lower interest rates since the lender earns more in interest payments over time. Short-term loans like balloon mortgages typically have higher rates.
10. Interest Rate Type
You can choose between a fixed rate that remains the same for the full loan term or an adjustable rate that fluctuates based on market indexes. Fixed rates offer stability but are usually higher. Adjustable rates start low but become unpredictable.
How to Get the Best Commercial Loan Rate
As you can see, there are many variables that determine what interest rate you will pay for commercial real estate financing. However, here are some tips to help you secure the lowest rate possible:
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Have a large down payment: Putting down 20% to 30% of the property value or more keeps your LTV low and results in better loan pricing.
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Ask about “lite” options: Some lenders offer commercial loans with limited reporting requirements that can have slightly lower rates for those with good credit.
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Improve your credit score: Pay down debts, avoid new inquiries, and resolve any errors to boost your score above 700.
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Enlist an experienced broker: A broker has relationships with many lenders and can help you find the most competitive rate.
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Compare multiple lenders: Apply with several lenders to leverage multiple rate quotes. Local, regional, and national lenders may offer vastly different pricing.
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Research index trends: Understanding whether key indexes like the prime rate are stable or climbing can inform if fixed or adjustable rates make sense.
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Extend the loan term: Opting for a 20- or 25-year mortgage often leads to a lower rate than a short 5- or 10-year loan.
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Lower the LTV: For the lowest rate, make a down payment of 25% or more of the property’s value to keep the LTV under 75%.
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Choose the right property: Financing lower-risk assets like industrial warehouses or grocery stores tend to offer better rates than hotels or restaurants.
By carefully optimizing these variables, commercial real estate investors can secure very competitive mortgage rates and minimize their long-term financing costs.
Commercial Loan Rate FAQs
What is a good commercial loan rate?
For a commercial real estate purchase or refinance, a good current interest rate is generally between 3% to 5% for the most creditworthy borrowers. Rates on the higher end of 6% to 9% are more typical.
How do lenders calculate interest rates?
Lenders consider the factors discussed above such as credit score, loan term, LTV, etc. to first determine a benchmark rate based on indexes like the prime rate. They then add a margin depending on the individual loan details to set the final interest rate.
What credit score do you need for the best commercial loan rates?
To qualify for the lowest rates, you generally need a credit score above 720 and ideally 740 or higher. Borrowers with scores in the 660 to 699 range can expect to pay more in interest.
Can you negotiate commercial loan rates?
Yes. Skilled commercial mortgage brokers know how to negotiate with lenders on your behalf to lower the initial quoted rate. Having multiple lender quotes also provides leverage to negotiate downwards.
How much does the down payment impact interest rates?
The more you put down, the better the rate since you’re asking to borrow less relative to the property’s value. Aim for at least a 25% down payment if possible.
Do longer loan terms have higher or lower rates?
Longer loan terms generally have lower interest rates, as the lender earns more interest over time. Short 1- to 5-year balloon loans typically have the highest rates.
Should you choose a fixed or adjustable rate?
Fixed rate loans currently have higher rates but offer stability. Adjustable rate mortgages start low but leave you vulnerable to rising interest costs over time as markets fluctuate.
By understanding the key factors that determine commercial loan pricing, you can strategically position yourself to qualify for the most favorable interest rate possible. Partnering with an experienced broker and shopping among multiple lenders also improves your chances of securing low-cost financing. With the right rate in place, your real estate investment can produce higher returns.
Factors Affecting Commercial Real Estate Interest Rates
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Economic Conditions
The existing economic conditions greatly impact commercial mortgages’ interest rates. Generally, interest rates are set based on the prime rate. The prime rate refers to the rate lenders charge clients for credit. Lenders set their own prime rates, but most banks rely on the rate that The Wall Street Journal’s compilation of the 30 largest banks in the country. In turn, the banks’ decisions are largely based on the Federal Reserve Board’s Federal Funds Target Rate, which can be adjusted to limit inflation.
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Your Profile
As a borrower, your profile, including your location, age, income, and expenses, impact the rates you’ll pay for a commercial loan. Borrowers with higher incomes tend to attract lower interest rates.
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Tenure of the Loan
The tenure of your commercial mortgage loan will impact the interest rates you’ll pay. Long-term loans attract lower rates because lenders regard these loans as lower risk.
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Your Credit Score
Generally, borrowers with a high credit score pay lower interest rates. A good credit score indicates to borrowers that you pose a lower risk. However, if you don’t have the greatest credit score, you can opt for a commercial mortgage lender that provides financing based on the value of your property rather than your credit.
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The Loan-to-Value Ratio (LTV)
This figure measures the amount of financing against the appraised value of the property. To calculate LTV, divide the loan amount by the property’s purchase price or appraised value (use the lesser of the two). The lower your LTV is, the more favorable your financing rates will be because having more stake in property equals a lower risk for the lender.
Commercial Real Estate Interest Rate: What Is It and How Is It Calculated?
Commercial mortgage interest rates are essentially rates your lender will charge you if you borrow to refinance, or purchase a commercial property. There is no single way of calculating interest rates. It all depends on the platform and loan product you choose. Private money lenders, debt funds, and banks use varying methods when calculating interest rates. However, most lenders use these common indexes when calculating interest rates:
The Federal Reserve regulates and calculates all these indexes; thus, market conditions can impact interest rates. For instance, due to market conditions, the Federal Reserve can increase or decrease the interest rates. So indexes change continually.