Why Are Commercial Mortgage Rates Higher
than Residential Mortgage Rates?
It’s true. Commercial mortgage rates are indeed slightly higher than residential mortgage rates - typically between 0.25% to 0.75% higher. If the property type requires active management - like a motel, marina, or RV park - your commercial loan rate is going to be even higher. But why?
The answer is that commercial real estate loans are fairly illiquid assets. Even if the commercial loan rate is high, in a crunch, commercial loans are difficult to sell. There is no organized secondary market for commercial loans. The holders of such notes cannot sell them quickly. A fun example will help you to understand:
Example: Your brother-in-law is in the military police. At 3:00 in the morning he calls you and his sister with a desperate warning. A strange virus has struck rural Iowa. Infected Americans have become flesh-eating zombies. Repeated attempts have been made to contain the infected population, but the military police keep getting overrun. It’s the Zombie Apocalypse! “Cash in your savings first thing tomorrow morning,” he urges you, “and buy guns, ammunition, dried survival food, and camping supplies.” The next morning you arrive at the bank at 7:59 am and withdraw all of your cash. You quickly spend it all on supplies. But what about your long-term savings? Well, you sold an apartment building three years ago. You carried back a $1 million commercial first mortgage at a delicious 9% interest rate. What a sweet investment! But no one will buy your commercial first mortgage note in a hurry. They all want a new appraisal or, at a minimum, a fresh property inspection. They all want to verify the notes payment history by looking at bank statements. Hurry, hurry! You are out of time. You simply have to bug out. That wonderful $1 million commercial first mortgage receivable proved to be worthless during a Zombie plague! It was illiquid.
“Okay, George, but why are home loans any better?”
You’ve heard of Fannie Mae and Freddie Mac. These are organized secondary markets, sponsored by the U.S. government, where conforming home loans are bought and sold by the hundreds every day. Conforming loans are residential first mortgages of less than a certain loan size and which have been underwritten to a certain credit quality. The borrower’s debt ratio needs to be less than a certain percentage of his income, the borrower’s credit score needs to be higher than a certain number, and the loan has to be less than a certain loan-to-value ratio. Conforming loans can be sold in hours, so they are very liquid assets. Investors will accept a lower yield if their investment can be quickly sold in an emergency.
Example: Johnny Flash, the founder and largest shareholder in your bank, intentionally drive his sports car off the highway and into a pillar. He dies instantly. No one know why. (In truth, his beloved hamster died.) Unfounded rumors start to swirl. He stole millions. The bank is bankrupt! Long lines of frightened depositors appear to withdraw all of their money. Its a bank run! The Executive Vice President of the bank orders his staff to sell every conforming home loan owned by the bank. He doesn’t even try to sell the bank’s commercial real estate loans. It would take far too long. Fortunately, by the end of the day, every panicky depositor is repaid in full. The bank is saved. Hooray! But at the next Board meeting, the new CEO sates, “Wow, that was a close one! Those commercial real estate loans were worthless in a pinch. We’re not going to make any more commercial real estate loans unless we can get a much commercial mortgage rate than we can get on a home loan."
NEED A COMMERCIAL LOAN RIGHT NOW?
If so, let’s get started. When you click on the maroon Submit Your Commercial Loan button below, you will be taken to C-Loans.com. This commercial mortgage portal will make your task of finding the best commercial lender much easier. Here’s why: Instead of filling out a separate commercial loan application for a half-dozen different commercial lenders, you will fill out just one mini-app. That same mini-app works for all 750 different commercial lenders. Based on the size of your loan request, the type of commercial loan you need (a conventional permanent loan versus a construction loan, etc.), the type of commercial property (apartments versus office, etc.), the location of your commercial property, and the condition of your credit, C-Loans will suggest 20 to 30 potential lenders. You put a check mark next to the six most attractive ones and then press “Submit”. Voila! Within minutes our hungry commercial lenders will be making you offers. And C-Loans is free!
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