Do you hold investment properties with variable interest rates?

Question

Just curious what other investors are doing regarding the short fixed interest period on commercial loans..

I suppose most would say that they wait to see what the market is doing at the time the variable interest rate kicks in after about 5-7 years but wasn’t sure what options are smart if interest rates are high and start to make the property less profitable, like refinance or selling etc..

thanks!

Jordan B. · Answer

@Dr. Jordan E Smith, as frightening as variable rates may seem on the surface there is much to consider when looking at the product.  One fact, going all the way back to 1971 to 2021 if you average the historical rates you get a little over 7%.  Keep in mind that has numbers as high 18% in the early 80's.  Also, look at the specific loan terms which are always negotiable.  These will be spelled out on the business and loan agreements from the bank.  There is a floor, or how low the rate can be adjusted.  There is a ceiling, or how high the rate can be adjusted.  There is also a subsequent adjustment cap, or the maximum amount the interest rate can move in one adjustment period, usually 2%.  And finally there is a lifetime adjustment cap, or the total limit the interest rate can increase from the initial rate over the life of the loan, commonly 5%.

Lets break it down a little bit, lets say hypothetically you took a loan out at 3.5% today with a 5 yr adjustable on a 20 year amortization.  Your floor is 2.5% and your ceiling is 7%.  Even if the worst case scenario happens and rates go up, due to your subsequent adjustment cap your rate can only go to 5.5% at the first 5 yr adjustment.

Here is the advantage of the variable rate to you vs your banker, lets say 7 yrs in rates drop to 2.5%, guess what you can call your lender and refinance your loan and get that 2.5% rate locked in for 5 years.  But within that 5 year period if rates go up its not like your banker can call you in and say hey we need to raise that rate, your locked in for your term.

So in summary, you are not putting yourself out there to end up with a 15% rate, there are many terms within the loan to protect you.  Read the fine print, negotiate the terms and understand your options.

David C. · Answer

I don't hold onto variable rate loans.  I personally only purchase 7 year fixed commercial loans and then weigh my options towards the end and then shop again, looking for the best 7-year fixed rate.  That being said, interest rates have been reasonable during the past 15 years, but I fear inflation is going to wreak havoc on rates in the near future.  So that may force me to adapt my model.  Hope that helps.

Dr. Jordan E Smith · Answer

That is super helpful information that I didn't know! thank you so much!

Dr. Jordan E Smith · Answer

Really appreciate the response, it does help. thank you!