Fixed Interest Rates and Variable Interest Rates in Commercial Real Estate
Every loan agreement comes standard with a form of interest that must be paid. Interest rates can be negotiable but usually appear in one of two forms: Variable or Fixed. A Variable Interest Rate loan has an interest rate on the outstanding balance that rises or falls based on the current status of the market interest rate. On the other hand, a Fixed Interest Rate loan has an interest rate that remains constant for the duration of the agreed loan term.
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What is the Difference Between a Fixed Interest Rate and a Variable Interest Rate? Which One is Better?
Every loan agreement comes standard with a form of interest that must be paid. Interest rates can be negotiable but usually appear in one of two forms: variable or fixed. A variable interest rate loan has an interest rate on the outstanding balance that rises or falls based on the current status of the market interest rate. On the other hand, a fixed interest rate loan has a constant interest rate for the duration of the agreed loan term.
Which one is better depends on the borrower's preference. Variable Interest rates may rise at any time. However, they may also fall. Fixed interest rates will not change either way, which excludes borrowers from paying less interest when the market interest rates decline. A fixed interest rate can be beneficial or detrimental all depending on the state of the market at the time the loan agreement is finalized.
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Related Questions
What is the difference between fixed and variable interest rates in commercial real estate?
Fixed interest rates and variable interest rates in commercial real estate are two different forms of interest that must be paid. A variable interest rate loan has an interest rate on the outstanding balance that rises or falls based on the current status of the market interest rate. On the other hand, a fixed interest rate loan has a constant interest rate for the duration of the agreed loan term. Variable interest rates may rise at any time, but they may also fall. Fixed interest rates will not change either way, which excludes borrowers from paying less interest when the market interest rates decline.
What are the advantages and disadvantages of fixed interest rates in commercial real estate?
The main advantage of a fixed interest rate loan is that the interest rate will remain constant for the duration of the loan term, regardless of the current market interest rate. This can be beneficial if the market interest rate rises, as the borrower will not have to pay more interest. However, if the market interest rate falls, the borrower will not benefit from the lower rate.
The main disadvantage of a fixed interest rate loan is that the borrower will not benefit from a lower interest rate if the market rate falls. Additionally, if the borrower needs to refinance the loan, they may not be able to get a lower interest rate than the one they already have.
What are the advantages and disadvantages of variable interest rates in commercial real estate?
The main advantage of a variable interest rate loan is that it can potentially save you money if the market interest rate declines. However, it also carries the risk that the interest rate could increase, which could lead to higher monthly payments.
The main disadvantage of a variable interest rate loan is that it carries the risk of increasing interest rates. This could lead to higher monthly payments and could make it difficult to budget for the loan. Additionally, if the market interest rate increases, it could be difficult to refinance the loan.
What factors should I consider when deciding between fixed and variable interest rates in commercial real estate?
When deciding between fixed and variable interest rates in commercial real estate, you should consider the current state of the market, the desired loan terms, and the risk associated with the loan. A variable interest rate loan has an interest rate on the outstanding balance that rises or falls based on the current status of the market interest rate. On the other hand, a fixed interest rate loan has a constant interest rate for the duration of the agreed loan term. A fixed interest rate can be beneficial or detrimental all depending on the state of the market at the time the loan agreement is finalized. Additionally, factors such as the desired loan terms, such as a 12-month bridge loan or a higher loan-to-value ratio, can affect the interest rate.
What are the current fixed and variable interest rates for commercial real estate?
The industry median interest rate for most commercial real estate loans usually falls approximately 3% above the effective federal funds rate. That said, different financing options have rates based on different indices. Many loans utilize the secured overnight financing rate, or SOFR, while others tie rates to the relevant Treasury yields. Others, like loans backed by the Small Business Administration, lock rates to the WSJ Prime. Learn more about current mortgage rates.
Fixed interest rates will not change either way, which excludes borrowers from paying less interest when the market interest rates decline. A fixed interest rate can be beneficial or detrimental all depending on the state of the market at the time the loan agreement is finalized. Variable Interest rates may rise at any time. However, they may also fall.
Are there any tax implications to choosing fixed or variable interest rates in commercial real estate?
The tax implications of choosing a fixed or variable interest rate in commercial real estate depend on the type of loan you choose. For example, with a CMBS loan, there are variations such as interest-only, variable-rate, and SASB conduit loans. Interest-only loans can be beneficial to borrowers as they increase property cash flow and bring up a property’s DSCR, meaning that a borrower may be able to qualify for a larger loan. However, variable-rate loans may lead to lower interest rates in the short term, but increase overall risks for borrowers. Fixed-rate loans are the most common type of CMBS loan and do not have any tax implications. For more information on fixed and variable interest rates, please see this page.