10 Year US Treasury

The Relationship Between Treasury Yields and Mortgage Rates

Most commercial lenders, including life insurance companies, CMBS (Commercial Mortgage-Backed Securities) conduits, and agency lenders like Fannie Mae and Freddie Mac, price their loans based on the 10-Year Treasury yield. The interest rate a borrower pays is typically composed of two distinct parts:

• The Index: This is the current yield of the 10-Year US Treasury.
• The Spread: This is the additional percentage (expressed in basis points) that the lender adds to the index to account for credit risk, property type, and profit margin.

The final interest rate is calculated as: 10-Year Treasury Yield + Lender Spread = Commercial Mortgage Rate.

Why the 10-Year Treasury Matters for Borrowers

Because the 10-Year Treasury represents the "risk-free rate of return," it is highly sensitive to economic shifts, inflation expectations, and Federal Reserve policy. For commercial real estate investors, the movement of this yield has several direct impacts:

• Volatility and Pricing: If the 10-Year Treasury yield rises quickly, commercial mortgage rates will follow suit, even if the lender's "spread" remains the same. This can affect a project’s debt service coverage ratio (DSCR) and overall affordability.
• Refinancing Risk: Borrowers with maturing loans must monitor the 10-Year Treasury closely. If yields are significantly higher than they were when the original loan was originated, refinancing can become more expensive or difficult.
• Cap Rate Correlation: Historically, there is a strong correlation between Treasury yields and capitalization rates (cap rates). When Treasury yields rise, investors often demand higher returns on real estate to justify the risk, which can lead to downward pressure on property valuations.
• Prepayment Penalties: Many commercial loans utilize Yield Maintenance or Defeasance as a prepayment penalty. These calculations are often tied directly to the movement of the 10-Year Treasury, meaning the cost to exit a loan early may fluctuate based on current Treasury yields.

The "Risk-Free" Benchmark

The 10-Year US Treasury is used as the standard because it matches the typical investment horizon of a commercial mortgage (which often has a 10-year term). Because the bond is backed by the full faith and credit of the US government, it is viewed as having zero default risk. Consequently, the "spread" added by commercial lenders represents the specific risk premium for the property asset class, such as office, retail, industrial, or multifamily housing.