What are 5-year Fixed Loans?

A 5 year fix loan is typically a 30 or 25-year amortized loans that is ‘due’ in 5 years.  The 5 years is usually an indicator of how long the interest rate will be fixed for.  After 5 years, the 5 year fixed loan shifts into a variable rate that adjusts typically twice a year, with a ceiling and basement rate that is pre-determined at the execution of the loan document.  A 5 year fix loan is very common in commercial real estate.

How is 5 year fixed loan different?

1. Rates are lower during the fixed-rate term, compared to 10-year and 7-year loans.  Since the rate is only fixed for five years, banks are willing to offer much more aggressive rates.  
2. The bank benefits due to a faster repayment after five years (through a sale or refinance), or allowing the loan to shift into a variable rate.  The borrowers benefits from a five year fixed loan by getting a lower rate, which means a lower monthly payment.  Real estate investors who are not planning to hold on to the property for longer than 5 years usually don’t mind the variable rate after 5 years, since they will either sell or refinance prior to the deadline.
3. Costs associated with a 5 year fixed loan are largely similar to loans with longer terms.  Since the vast majority of 5 year fixed loans are given to commercial investors, not homebuyers – the differences to a standard 30-year home mortgage are substantial, but those are simply two different loans.  

What are the risks behind a 5 year fixed loan?

 1. Higher risk – 5 year fixed loans are riskier, since the loan will shift to a variable rate after 5 years.  It is not uncommon to see a jump of 2-3% points, even with traditional big banks.  Most loan structures however, will provide that a rate adjustment can only happen a few times a year.  5-year fixed loans are not advisable to investors who are planning to own the property for more than 5-years and expect a rising interest rate environment like today
2. Stricter Underwriting – since a 5 year fixed loan is considered ‘risker’ than 10-year loans, banks will underwrite them using stricter standards. For example, a more conservative DCR will apply to give the bank more security for income/debt.

Who is it for?

1. Commercial real estate investors with a 2-5 year plan
2. Real estate investors who are planning to sell/flip the property before the term expires
3. Real estate investors who are purchasing a low-cap rate property and therefore need a lower monthly payment that a 5 year fix loan can provide with a lower rate.  This is ideal for investors who want to reposition the property with a better tenant and refinance to a longer term loan later.

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