Fixed or floating rate? Choosing your loan structure

Choosing between a fixed rate and a floating rate is one of the first decisions on any commercial loan. It shapes your payment, your prepayment options, and how much risk you carry if markets move. Neither choice is right in every case. The right answer depends on how long you plan to hold the asset, what you plan to do with it, and how much payment uncertainty the property or business can absorb.

How each structure works

A fixed rate loan sets the interest rate at closing for a defined term. Your payment is known in advance. That certainty usually comes with tighter terms on early payoff.

A floating rate loan resets on a schedule. The rate is an index, often SOFR for US commercial loans, plus a fixed spread the lender sets at closing. When the index moves, your payment moves with it.

Some loans blend the two. A hybrid may fix the rate for the first few years and then float, or float with a cap that limits how high the rate can go.

What you give up with a fixed rate

Payment certainty has a cost. It shows up in a few places:

• Prepayment penalties. Lenders who fix your rate often fund that loan with matched capital. If you pay off early, they want to be made whole. That can mean a step down schedule, yield maintenance, or defeasance.
• Less flexibility. Selling, refinancing, or recapitalizing before maturity can become expensive.
• Starting cost. Depending on the shape of the yield curve, a fixed rate can price above or below the current floating rate on day one.

A fixed rate fits best when you plan to hold a stabilized asset for the full term and want a predictable debt service number for budgeting and distributions.

What you take on with a floating rate

Floating rate debt is common on bridge loans, construction loans, and transitional business plans. The appeal is flexibility. These loans often carry little or no prepayment penalty after a short lockout, so you can refinance or sell once the plan is complete.

The tradeoff is exposure. If the index rises, your interest cost rises. Lenders know this. Many require an interest rate cap, and they size the loan against a stressed rate rather than today's rate. That can reduce your proceeds even when the current payment looks comfortable.

Floating rate debt tends to fit when:

• You expect to sell or refinance within a few years.
• The property is in lease up or renovation, and income will grow.
• You value the option to exit without a large penalty.

Questions to answer before you choose

How long will you hold?

Match the rate structure to the business plan. A five year hold on a stabilized building points one way. An eighteen month value add plan points another.

Can the deal carry a higher payment?

Run your coverage at a higher rate than today's. If debt service coverage falls below what the lender requires, or below what you are comfortable with, a floating loan may need a cap, more equity, or a different structure.

What will it cost to get out?

Price the exit, not just the entry. Ask the lender to show the prepayment cost at several points in the term. A loan that looks cheaper at closing can cost more if you sell in year three.

Who else has a say?

Partners, investors, and guarantors may have their own views on risk. Agree on the approach before you sign a term sheet.

Getting the structure right

Rate type is one piece of a broader decision. Term, amortization, recourse, and prepayment terms all interact. A useful exercise is to model two or three structures side by side and compare total cost under a few rate scenarios and exit dates. The cheapest headline rate is not always the cheapest loan.

To see how rate assumptions change your loan amount, try the debt sizing tool. If you would like a second opinion on how to structure an upcoming acquisition or refinance, reach out to our team.