Adjustable Rate Mortgages (ARMs) are loans whose interest rates can vary (adjust) during the loan term. These Adjustable Rate Commercial Property Loans usually have fixed interest rates for an initial period of time. Subsequently they interest rate “adjusts” based on the index used and the underlying current market conditions. The initial rate on an ARM is lower than on a fixed rate mortgage which allows you to afford and purchase a higher end commercial property.
Adjustable rate commercial mortgages are usually amortized over a period of 30 years. Initially the rate is fixed from 1 month to thirty (30) years. All ARM loans have a “margin” plus an “index.” Margins on loans range from 1.00% to 3.50%. This depends on the index and the amount financed in relation to the property value. Of course this goes along with a myriad of other potential factors. The index is the financial instrument that the ARM loan uses for its adjustments. These include: 1-Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime Rate, 6-Month Certificate of Deposit (CD) and the 11th District Cost of Funds (COFI), to name a few.
Interest Rate Adjustments
When the time comes for the ARM to adjust, the margin will be added to the index. This new interest rate yield is typically rounded to the nearest 1/8 of one percent. That rate will then be fixed for the next adjustment period. This adjustment can occur every year, but there are factors limiting how much and how often the rates can adjust. These factors are called “caps.” Suppose you had a “3/1 ARM” with an initial cap of 2%, and a lifetime cap of 6%. Let’s say it also had and initial interest rate of 6.25%. Therefore, the highest rate you could have in the fourth year would be 8.25%. And, the highest rate you could have during the life of the loan would be 12.25%. Again, this is just an example.
Some commercial ARM financing has a conversion feature that would allow you to convert the loan from an adjustable rate to a fixed rate. There is a minimal charge to convert the loan. However, the conversion rate is usually slightly higher than the market rate that the lender could provide you at that time by refinancing.