Commercial loan rates are essentially the combination of the underlying index and the margin that the funding bank or lender charges. Borrowers should be careful on the way that their term sheets are written in regards to quoted rates. Below are a few suggestions on how you can protect yourself against having your commercial loan rate increased (bait and switch) while in process.
First of all, an indexes commonly used in the commercial mortgage industry includes Prime and the 10 Year Treasury. Less well known indexes such as the 5 Year Swap or the FHLB indexes are becoming more popular.
The margin is where the bank makes its spread. It is a very complicated process for banks to figure out what to charge as they basically have to predict the future and take into account the probability of default, adequately cover their costs, and of course try to make a profit. At the same time the industry is highly competitive and they have to price out their loans "skinny" enough to be able to bring in new borrowers.
The combination of the margin and index is commonly referred to as the Effective Rate. It's what the borrower will use to calculate their payments and what they normally think of when they ask for rate quotes. For example if a bank quoted you Prime plus 1% your Effective Rate would be 6% as prime right now is at 5%.
The main suggestion regarding not having your rate bumped up on you while your loan is in process is to have both the margin and index clearly written on the term sheet. The opposite is to just have the effective rate quoted with no mention as to either the margin or the index. If either or both go down for example, you would not know, and would not know that your rate should be lower. The lender could simply keep your rate the same and you would have no recourse or really any way of knowing.
A worse scenario would be to have your rate increase during process. Rate locks are rare in the commercial mortgage industry so it is possible for the funding bank to call you with the bad news that your rate will be higher. In fact, as of this writing 5/8/8, it's not that uncommon at all, as banks are constantly rethinking what they can and what they want to lend on - due to the credit crisis. And many will have the attitude of, take it or leave it. More to the point though if the margin and index are not clearly known the lender could mention any margin or index when challenge to "cover" his story.
Get it in writing or assume they will try the bait and switch on your commercial loan rate.
Jeff Rauth is President of Commercial Finance Advisors, Inc out of Birmingham, Michigan. He specializes in Commercial Real Estate Loans between $400,000 - $5,000,000. Offers unique loan programs such as Commercial Second Mortgages, Commercial 30 Year Fixed and 90% non SBA financing, Commercial Equity Lines. 248 885-8797 or at SBA 7a Loans or commercial loan rates or commercial loan calculator
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