Loan Term

Definition of Loan Term

In the context of commercial mortgages, the loan term refers to the legally binding duration during which the borrower is obligated to make payments and at the end of which the remaining principal balance must be paid in full. Unlike residential mortgages, where the loan term and the amortization period are often the same (e.g., a 30-year fixed mortgage), commercial loan terms are typically much shorter than the time required to pay off the debt through scheduled installments.

Detailed Description of Commercial Loan Terms

The structure of a commercial loan term is a critical component of a property’s capital stack and influences the borrower's long-term exit strategy. Below are the primary characteristics and considerations regarding loan terms in commercial real estate:

• Term vs. Amortization: While a commercial loan may have an amortization period of 25 or 30 years to keep monthly payments affordable, the loan term is often only 5, 7, or 10 years. This mismatch means that the monthly payments do not fully pay off the loan by the time the term expires.
• Maturity Date: The final day of the loan term is known as the maturity date. On this date, any remaining principal—often a significant amount—becomes due immediately.
• Balloon Payments: Because the loan term is shorter than the amortization schedule, the final payment is usually a balloon payment. Borrowers typically satisfy this large sum by either refinancing the property into a new loan, selling the asset, or using cash reserves.
• Interest Rate Impact: Generally, the length of the loan term correlates with the interest rate. Shorter terms (such as 3-year bridge loans) may carry higher rates due to increased risk or specific project needs, while 10-year "perm" loans often offer lower, fixed rates but may come with stricter prepayment penalties.
• Prepayment Penalties: Commercial loan terms are frequently protected by prepayment structures like yield maintenance or defeasance. These provisions prevent the borrower from paying off the loan early without significant cost, ensuring the lender receives a guaranteed return for the duration of the agreed-upon term.

Common Types of Commercial Loan Terms

The "right" loan term depends on the borrower's business plan for the underlying real estate:

• Short-Term (Bridge Loans): Typically 1 to 3 years. These are used for properties undergoing renovation, lease-up, or "stabilization" before seeking long-term financing.
• Mid-Term: Typically 5 to 7 years. These are common for stabilized assets where the borrower wants to balance interest rate stability with the flexibility to sell or refinance in the medium term.
• Long-Term: 10 years or more. These are standard for institutional-grade assets or "buy-and-hold" investors who want to lock in financing for a decade to hedge against interest rate volatility.

Understanding the loan term is essential for commercial investors, as it dictates the timeline for refinancing risk. If a loan term ends during a period of high interest rates or a market downturn, the borrower may face challenges in renewing the debt or selling the property to cover the balloon payment.