When Does it Make Sense to Buy Down the Rate on Your Commercial Loan?
“It depends.” While this phrase is never what one wants to hear when asking for advice, the truth is that in many different circumstances, the best course of action really does depend on a number of distinct factors.
When choosing between different options on a commercial mortgage loan, “it depends” becomes a common refrain. That is because the ideal loan depends squarely on the borrower’s specific situation and long-term financial goals.
For instance, when you take out a commercial loan, you can choose to buy down the interest rate. This means you will pay more up front in order to lock in a lower interest rate throughout the life of the loan. Is this the best action to take? Well, it depends.
Here are a couple essential questions to ask yourself before you choose whether or not to buy down your commercial loan’s interest rate at closing.
First – a quick rundown on rate buy downs:
A buy down occurs when a borrower pays a fee at the beginning of their loan’s term in exchange for points that are then applied to reduce their monthly interest rate.
Let’s say you’re looking to take out a $1 million loan on a 5-year term. You’re trying to determine whether you can save more by paying 1 point ($10,000) up front to reduce rate and margin for the mortgage’s term or simply make the regular monthly payments for the duration of the loan.
|Term||5 years||5 years|
|Amortization||30 years||30 years|
|Monthly Principal & Interest Payment||$6,893.62||6,636.42|
In this case, you would save $257 per month. In other words, payments would be reduced by $15,432 over the course of the loan.
- How long do you plan on keeping the property?
The above scenario makes a solid case for buying down a rate at the beginning of your loan’s term. But what if you do not plan on owning the property for a long period of time?
Borrowers who plan to sell their commercial property before the end of the loan term should plan carefully. If they sell too early, they may end up paying more for the buy down than they would if they had just made regular monthly payments.
It can take many years before you see the benefit of your initial commercial loan rate buy down. So evaluate your long-term financial goals and general investment strategy to ensure your decision makes the most amount of sense.
- Do you have the necessary cash flow right now?
Buying down a monthly interest rate requires a significantly larger investment than you may have anticipated before you began shopping for a commercial loan. Depending on the current state of your business or general finances, it may not make sense to pay a higher amount up front.
It is also important to consider the additional fees you may have to pay when securing your commercial mortgage. Even if your business is generating a healthy amount of revenue, you might not wish to pay more than you need to.
On the other hand, those who are able and willing to increase their initial payment will position themselves to benefit down the road.
A final word about rates:
Hunting for the lowest possible rate can be a dangerous strategy. All too often, the lowest rate comes with the strictest terms and fewest options.
Instead, try to adjust your perspective and search for the best overall loan option. And remember that the best option will – you guessed it – depend on your specific set of needs.
If you’re looking for a flexible, reduced documentation solution but you’re struggling to find a low rate option, remember that a rate buy down could be a beneficial alternative.
If you need a commercial loan and you’re looking for more options and greater flexibility, be sure to visit Commercial Direct’s Loan Customizer today. Once there, you can design a loan request that matches your specific needs.