Why Are Commercial Loan Terms So Short?

Commercial loan borrowers are constantly asking for commercial loan products with ten, fifteen, twenty, and thirty-year fixed rates and terms.  What many borrowers do not understand, especially first time commercial loan borrowers, is that long-term fixed rates over five-years are rare and don’t really exist in the commercial loan marketplace, with a few exceptions.

The confusion often lies in the fact that borrowers can get 15 to 30 year fixed rate and term residential mortgage loans, and they think the same should apply for their commercial loan.  The primary difference is in how these different loans are funded.  Home mortgage loans are typically made by Banks or residential mortgage lenders, but in most cases the Bank’s do not retain ownership of these loans.  The loans are sold to the secondary mortgage market where they are pooled into mortgage-backed securities, which are sold into the equity markets.  Investors purchase mortgage-backed securities for the long-term fixed interest rate of return they provide as they are typically seen as a safe investment as most mortgage-backed securities are guaranteed by the Federal Government or carry insurance that provides guaranty of payment of principal and interest.

Commercial loans on the other hand are typically held by the commercial banks or the commercial lenders that make them.  Banks, as an example, typically lend out their deposits.  Banks attract the deposits they lend usually by offering a rate of return on different deposit accounts, such as money market accounts, savings accounts, and certificates of deposit.  As most depositor money is put into Bank’s on a short-term basis, or in the case of a checking or money market account could be moved out at anytime, Bank’s must quickly adjust their interest rates to keep deposits in the Bank when the market shifts.  Because of this, if interest rates paid for deposits in the market start to go up, Bank’s must increase their interest rates.  This affects the Bank’s capital cost.  Since Bank’s determine the interest rates they can charge their commercial loan customers largely based on the Bank’s internal costs, any change up or down in interest rates effects their returns.  Because it is hard for Banks to forecast interest rates very far into the future, they are hesitant to lock interest rates in for very long.  Which is why most commercial loan terms and interest rate locks do not exceed five years or are even less than that.

Now, in some cases commercial lenders run a product special where they may offer a longer-term fixed interest rate and term.  And in some cases commercial lenders will offer longer-terms, but will have the rate adjust to market rates at some point during the term to be sure they are covered should their cost of deposits change during that loan term.  There are some lending programs, such as some multifamily lending programs offered through Fannie Mae & Freddie Mac that offer longer-term fixed rates, or some programs funded by insurance companies, but these are rare and most commercial loan borrowers do not qualify for these programs.  The programs are usually designed for assets that have long-term income potential, such as large well-located apartment buildings or retail centers with strong national tenants on long-term leases.

It would be nice if a secondary commercial loan market existed allowing commercial loan borrowers to lock in long-term fixed interest rates on long terms, but that is unlikely to happen.  Commercial loan requests are so different from one another, it is hard to create a product or products the market can get comfortable with.  Unlike residential lending, which is very standard, most commercial loans by the nature of their cash-flow and the assets that secure the loans, do not warrant long-term fixed interest rates.  It does not make sense to put a retail center with leases that do not exceed five years on a term longer than the five years the leases last.  Commercial lenders do not want to commit to provide money for longer than the borrower can evidence the ability to repay the loan.  Even without those options, there are still many good loan options out there for commercial loan borrowers, and we here at CLX are more than happy to help borrowers find the options that best fit their needs.