The cheaper commercial property loan is often the one with the higher rate

When an Australian business owner shows me two commercial property loan offers, the first question is almost always the same: which rate is lower? It is the wrong question. On a commercial facility, the headline rate is one line in a contract that can carry five or six other costs, a reset clause and a set of covenants that let the lender reprice you later. Two offers with the same rate can cost very different amounts, and an offer with a higher rate can be the cheaper loan.

Here is how to read a quote the way a lender prices it.

The rate is two numbers, not one

A commercial property rate is built from a benchmark plus a margin. The benchmark is a reference rate, such as the Reserve Bank's cash rate or a bank bill rate, and it moves with the market. The margin is the lender's charge for the risk it sees in your file: your leverage, the strength of your repayment source, the type of property and, for an investment, the lease.

Splitting the two tells you what you are actually being charged for. If the benchmark moves, every borrower moves with it. If your margin is wide, that is about you, and it is the part you can do something about. For a closer look at how lenders build the number, this breakdown of pricing on commercial property finance sets the published figures against what a facility actually charges.

Count the fees over the time you will actually hold the loan

Establishment fees on commercial facilities commonly sit around one per cent of the loan, and they bite hardest on a short hold. Add valuation and legal costs, any monthly or annual line fee, a discharge fee and, on some products, an early repayment fee of around two per cent if you leave in the first few years.

Take two illustrative offers on a $1,000,000 interest only loan held for two years. Offer A is 7.00 per cent with a $10,000 establishment fee, $4,000 of legal and valuation costs and a $1,000 annual fee. Offer B is 7.20 per cent with a $2,500 establishment fee, the same $4,000 of legal and valuation costs and no annual fee. Over two years, Offer A costs about $156,000 and Offer B about $150,500.

The higher rate wins by more than $5,000. Stretch the hold to ten years and the answer may flip, which is the point: the right offer depends on how long you expect to keep it.

Know when your rate actually moves

Business owners often assume their repayment changes the day a rate decision is announced. Many commercial facilities only reprice at a contractual reset, which might be monthly, quarterly or at an annual review. A fixed rate holds for its term but carries a break cost if you exit early, and that cost is calculated from wholesale rate movements, not set in advance. Ask how it is calculated before you fix, not after.

The arithmetic of a move is simpler than the anxiety around it. On an interest only balance, the extra interest is the balance multiplied by the change. A quarter of a point on $2,000,000 is about $5,000 a year, but only from the date your contract says the new benchmark applies.

The annual review is where margins move quietly

The cash rate does not need to change for your rate to change. Most commercial facilities are reviewed annually, and the review is when a covenant is tested, a revaluation shifts your loan to value ratio, or a lease expiry changes how the lender sees the security.

A revaluation is the one that catches people. A $1,200,000 loan against a property valued at $2,000,000 is a 60 per cent loan to value ratio. If a later valuation comes in at $1,600,000, the same loan is 75 per cent. Nothing about the loan changed, but the risk the lender sees did, and so can the margin it is willing to hold.

Documentation changes the lender set, not just the price

Self-employed borrowers whose financials lag behind their trading often go to lenders that accept lighter documentation: bank statements and business activity statements, or the lease and rent schedule on an investment property. That is a legitimate pathway, but it carries a loading over full documentation at the same leverage, and the maximum loan to value ratio usually falls as the evidence thins. Sometimes the cheapest thing a borrower can do is lodge the overdue tax return and come back a quarter later as a full documentation file.

Owner-occupied and investment property are assessed differently too, though not in a fixed direction. Premises you trade from are repaid mainly from your business cash flow. An investment relies on the tenant, so lease length and tenant quality carry more weight.

Before you sign

Ask each lender for the same things in writing: the benchmark, its tenor and reset frequency; whether the margin is locked for the term; every fee, including discharge and break costs; the covenants and revaluation rights; and the repayment under a higher benchmark. Then compare the total dollar cost over the period you expect to hold the loan.

If you are refinancing, run the payback. A margin improvement of a quarter of a point on $1,000,000 is about $2,500 a year. If the move costs one per cent of the loan to execute, it takes roughly four years to earn that back. A shorter remaining hold makes the fees hurt more, not less.

The rate on the first page of an offer is the number lenders compete on because it is the number borrowers look at. The number that matters is the one you work out yourself.

Nick Lim is an FBAA accredited finance broker and the founder of Switchboard Finance, a Melbourne brokerage that arranges non-bank lending for self-employed business owners.

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