Published February 4, 2012
In 1933, in the aftermath of the Great Depression, President Franklin D. Roosevelt established, with Congress, The Home Owners Mortgage Act by selling government bonds to lenders. The purpose was to help remedy high foreclosure rates and to make it possible for more people to own their own homes. It was mandated that these loans had to be fixed for 20 to 25 years and be fully amortizing (term and amortization match). Eventually this was pushed up to 30 years, with the idea that most people would work for 30 years and then retire with a paid-off home.
In commercial financing, commercial loans do not have this platform. Most banks borrow money overnight wholesale and sell it to you retail. The commercial lender has to be aware of his cost of funds. He needs to make a comfortable margin above the cost of funds to earn a profit. If he fixes your rate on a commercial loan for too long and rates go the wrong direction, he can actually lose money on the transaction. It is much safer for a commercial lender to lend the money to you on a monthly adjustable rate. Therefore if the rates on the money they borrowed go up, they can raise your rates accordingly. But most commercial borrowers want the safety of a longer fixed-rate period. As a result, most banks only offer commercial loans with three- to five-year fixed rates. Commercial lenders that lend out their own money (portfolio lenders) can lend it out for longer fixed-rate periods without this risk. These commercial lenders, in most cases, have higher rates.
Some commercial lenders sell your loan in a mortgage pool. Your loan is bundled with other commercial loans with like maturities and sold as a mortgage-backed security bond on Wall Street. Fannie Mae and Freddie Mac purchase multifamily commercial loans under this scenario. These commercial loans are usually fixed for 5, 7, 10, 15, or 20 years or more. Keep in mind that the investors are guaranteed a rate of return on their investment for the same fixed period, so if you decide to prepay early, there could be a sizable prepayment penalty.
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By Terry Painter, President