Interest Rate Rounding

Interest Rate Rounding in Commercial Mortgages

Interest rate rounding is a contractual provision in a commercial mortgage agreement that dictates how the final interest rate is calculated when the rate is based on a fluctuating index. In commercial real estate finance, most floating-rate or adjustable-rate loans are determined by adding a predetermined margin (or spread) to a base index, such as the Secured Overnight Financing Rate (SOFR) or a specific Treasury yield. Since these indices often result in complex decimal figures, rounding is used to simplify the final rate into a standardized increment.

The rounding process ensures that the interest rate remains consistent with industry standards and simplifies the calculation of monthly debt service payments. While it may appear to be a minor administrative detail, the specific method of rounding can have a measurable impact on the total interest paid over the life of a multi-million dollar commercial loan.

Detailed Description and Mechanics

When a commercial loan reaches its "Reset Date" or "Adjustment Date," the lender takes the current value of the index and adds the margin. The resulting figure is then adjusted according to the rounding increment and rounding direction specified in the Promissory Note.

Common elements of this process include:

• Rounding Increments: The most common increment in commercial lending is one-eighth of one percentage point (0.125%). Other frequent increments include one-tenth of one percent (0.10%) or one-quarter of one percent (0.25%).
• Rounding to the Nearest: Under this method, the rate is adjusted to the increment that is mathematically closest to the calculated sum. For example, if the index plus margin equals 6.11% and the rounding increment is 0.125%, the rate would round to 6.125%.
• Rounding Up: Some commercial contracts specify that the rate must always be rounded up to the next increment. This is generally more favorable to the lender, as it slightly increases the effective yield of the loan.
• Rounding Down: Though less common in institutional commercial lending, a contract may specify rounding down to the nearest increment, which slightly benefits the borrower's cash flow.

The Impact on Commercial Borrowers

In the context of commercial mortgages, where principal balances are high, even a small fraction of a percent matters. For example, on a $10,000,000 loan, a rounding difference of 0.05% equates to $5,000 in additional interest per year.

Borrowers and their legal counsel typically review the rounding clause during the loan commitment phase to ensure it aligns with market standards. Because most commercial loans are serviced using automated software, the rounding rule must be explicitly defined to avoid calculation discrepancies between the borrower's internal accounting and the lender’s billing statements. If the loan documents are silent on rounding, the lender typically uses the exact mathematical sum of the index and the margin, which is often referred to as the "actual" or "unrounded" rate.