A commercial mortgage is a loan used to buy or refinance income-producing property, and it works very differently from a home loan. The borrower is almost always a business entity rather than an individual. The property’s rental income, not the owner’s paycheck, drives the approval decision. And the loan term almost always ends in a balloon payment that forces you to refinance or sell within five to ten years, even though the monthly payment is calculated as if you had 25 or 30 years to pay it off. Qualifying properties range from office buildings and retail centers to industrial warehouses and apartment complexes with five or more units. The sections below walk through how lenders size the loan, what the structure looks like, where the real costs sit, and what happens if things go wrong.
How Lenders Decide Whether to Lend
The single most important number in a commercial mortgage application is the Debt Service Coverage Ratio. Lenders calculate it by dividing the property’s net operating income (revenue minus operating expenses) by the annual loan payments. A ratio of 1.0 means the property earns exactly enough to cover the debt. Most lenders want to see at least 1.20 to 1.35, meaning the property generates 20% to 35% more income than the loan costs. That cushion is what protects the lender when vacancies spike or a roof needs replacing.
Loan-to-value ratios run considerably lower than in residential lending. Federal interagency guidelines set regulatory ceilings at 65% for raw land, 75% for land development, and 80% for commercial construction or multifamily projects, with improved commercial property allowed up to 85%. In practice, most conventional commercial lenders cap loans at 65% to 80% of appraised value depending on property type and borrower profile. Hotels, self-storage facilities, and other operationally intensive properties land at the low end because their income depends on active management rather than long leases.
Underwriters don’t stop at the subject property. They perform a global cash flow analysis that pulls in every business the guarantor owns, rental income from other properties, personal income, and all outstanding debts across every entity. The question they’re trying to answer is whether the borrower can keep servicing the loan if the property underperforms for a stretch. A strong personal credit score (typically 700 or above) helps secure better rates, but it won’t rescue an application where the property’s own numbers fall short.
Loan Term, Amortization, and the Balloon Payment
Most commercial mortgages separate two timelines that residential borrowers never think about. The amortization schedule (usually 20 to 30 years) determines how your monthly payment is calculated, keeping it manageable by spreading principal across decades. The loan term (often five to ten years) is when the full remaining balance comes due. Whatever principal you haven’t paid off by that date becomes a balloon payment. If you can’t refinance or sell by maturity, you’re in default.
This is where commercial lending gets dangerous for borrowers who don’t plan ahead. A property purchased with a ten-year term and a 25-year amortization will still carry roughly 75% of the original loan balance when the balloon comes due. Start the refinancing process at least six to twelve months before maturity. Underwriting a commercial loan takes time, and market conditions at maturity may look nothing like they did at origination. Rising rates or declining values can make refinancing significantly more expensive at the same leverage, or impossible.
Interest Rates: Fixed, Floating, and Hedging
Commercial mortgage rates come in two flavors. Fixed rates lock in your cost of capital for the full loan term, making cash flow projections reliable. As of early 2026, conventional bank rates range roughly from the high 4% range to nearly 9%, with CMBS loans typically falling between about 6% and 8%. The spread reflects differences in property quality, leverage, and borrower strength.
Variable-rate loans float above a benchmark, most commonly the Secured Overnight Financing Rate (SOFR) or the lender’s prime rate, plus a margin that usually falls between 2% and 4%. The margin stays constant while the benchmark moves with market conditions and Federal Reserve policy. Floating rates start lower than fixed rates but expose you to payment increases if the benchmark climbs.
Two hedging tools let you manage that exposure. An interest rate cap sets a ceiling on how high your effective rate can go. You pay an upfront premium, and if the benchmark exceeds the cap level, the cap provider covers the difference. Many lenders require one on floating-rate deals. An interest rate swap lets you exchange your floating payments for a fixed rate without an upfront premium, but you give up any benefit if rates fall below the swap rate. Swaps suit borrowers who want certainty; caps suit borrowers who want protection while still benefiting from declining rates.
Prepayment Penalties
Paying off a commercial mortgage early sounds like a good thing, but lenders price their returns based on receiving interest for the full term. Prepayment penalties protect that expected yield, and they are far more punishing than anything residential borrowers face. Three structures dominate the market.
Yield maintenance requires you to pay the remaining principal balance plus a penalty calculated as the present value of all the interest the lender would have received through maturity, discounted using a Treasury yield near the loan’s maturity date. This is the actual prepayment of the loan, and it tends to be the most expensive option when rates have fallen since origination.
Defeasance works differently. Instead of paying off the loan, you substitute the real estate collateral with a portfolio of government bonds that replicates the remaining payment stream. The loan continues to exist and a successor entity assumes it, while you walk away with unencumbered real estate. Costs include the bond portfolio plus fees to attorneys, accountants, and a rated securities intermediary.
Step-down penalties are the simplest and most borrower-friendly of the three. A declining percentage is applied to the outstanding balance based on how far into the term you prepay. A common schedule on a five-year loan is 5% in year one, 4% in year two, 3% in year three, and so on.
Which structure applies depends on the lender. CMBS loans almost always require yield maintenance or defeasance. Bank loans more commonly use step-down schedules or lockout periods (a window during which prepayment isn’t allowed at all). Negotiate prepayment terms at origination, because refinancing or selling mid-term with a costly prepayment provision can wipe out a substantial portion of your profit.
Recourse vs. Non-Recourse
One of the most consequential terms in a commercial mortgage is whether the loan is recourse or non-recourse. In a recourse loan, the borrower or guarantor is personally liable for the full debt. If the property goes to foreclosure and sells for less than the outstanding balance, the lender can pursue the borrower’s other assets to recover the shortfall. In a non-recourse loan, the lender’s recovery is limited to the property itself.
Non-recourse sounds like a free lunch, but lenders compensate for the added risk with lower leverage, higher rates, and stricter underwriting. CMBS loans are almost always non-recourse. Bank loans, particularly for smaller deals, tend to be full recourse with a personal guarantee from the principals.
Even non-recourse loans include exceptions called “bad boy” carve-outs that trigger full personal liability for certain borrower actions. Filing voluntary bankruptcy, transferring the property without lender consent, placing unauthorized secondary financing on the property, or committing fraud will convert a non-recourse loan into a recourse one. Committing environmental waste, failing to maintain insurance, or misappropriating insurance proceeds can also create limited personal liability for the losses those actions cause. These provisions are negotiated at origination and are worth reading carefully, because the consequences are severe.
Who Makes Commercial Loans
Who originates your loan shapes everything about the experience: the rates, the flexibility during the term, the prepayment structure, and what happens if you need to restructure.
Banks and credit unions are the most common source for small to mid-size commercial loans. They offer recourse loans with flexible terms, step-down prepayment, and relationship-based underwriting. Because they hold the loan on their own books, they can work with you if problems come up mid-term. Rates are competitive for borrowers with strong credit and existing banking relationships.
CMBS conduit lenders originate loans, package them into bonds, and sell them to investors. CMBS loans are non-recourse with leverage up to about 75%, but they come with rigid terms, yield maintenance or defeasance requirements, and outsourced servicing. If you need flexibility during the term, CMBS is the wrong product. If you want non-recourse debt at reasonable leverage, it’s one of the few options available.
Life insurance companies offer the lowest rates in the market but are the pickiest lenders. They favor high-quality properties in major markets, cap leverage around 50% to 65%, and perform exhaustive borrower-level underwriting. In exchange, they offer terms up to 25 years, sometimes fully amortizing with no balloon, and because they keep loans on their books, servicing is handled in-house.
Bridge and private lenders fill the gap when a property doesn’t qualify for conventional financing because of vacancy, needed renovations, or a tight closing timeline. Rates are significantly higher, terms are short (typically 12 to 36 months), and fees are steep. Bridge debt is a temporary tool to stabilize a property before refinancing into permanent financing.
SBA 504 and 7(a) Loans
Small businesses that plan to occupy the property they’re purchasing have access to two government-backed programs with substantially better terms than conventional commercial mortgages. SBA 504 loans are specifically designed for owner-occupied commercial real estate. The structure splits the financing three ways: a conventional lender provides about 50% of the project cost, a Certified Development Company backed by the SBA provides up to 40%, and the borrower puts down as little as 10%. The maximum 504 loan amount through the CDC portion is $5.5 million. Existing-building purchases require the borrower to occupy at least 51% of the space; new construction requires 60%.
SBA 7(a) loans are more flexible and can be used for real estate, equipment, or working capital, with a maximum loan amount of $5 million. Both programs offer longer repayment terms (up to 25 years for real estate) and lower down payments than conventional lenders require. SBA 504 rates in early 2026 have been running in the high 5% range, well below comparable conventional bank rates. The trade-off is a slower approval process and more paperwork.
Closing Timeline and Costs
From application to funding, a conventional commercial mortgage typically takes 45 to 65 business days. Once the lender accepts the application, underwriters order a certified commercial appraisal and a Phase I Environmental Site Assessment. The appraisal analyzes comparable sales, income projections, and replacement costs to determine fair market value, generally costing between $2,000 and $5,000 and taking three to four weeks. The Phase I identifies potential contamination from current or historical uses of the property and surrounding land, running $2,000 to $4,000 for standard commercial property. If the Phase I flags concerns like underground storage tanks or evidence of chemical spills, a Phase II with actual soil or groundwater testing follows, adding significant cost and time.
After underwriting approves the deal, the lender issues a commitment letter laying out final terms. At closing, the borrower signs a promissory note (the promise to repay) and a mortgage or deed of trust (the instrument that gives the lender a lien on the property). The lender also files a UCC-1 financing statement to secure an interest in personal property and fixtures located on the premises, such as trade fixtures and installed equipment that might not be covered by the mortgage lien alone.
Beyond the down payment, budget for the following at or before closing:
- Origination fee: typically 0.5% to 1% of the loan amount, sometimes negotiable on larger deals.
- Appraisal: $2,000 to $5,000.
- Phase I Environmental Assessment: $2,000 to $4,000.
- Title insurance: varies by state and property value. On a $1 million property, premiums often fall between $2,000 and $8,000.
- Mortgage recording taxes: charged by some states and counties on the loan amount, ranging from about 0.1% to nearly 2% where they apply.
- Legal fees: both borrower’s and lender’s attorneys bill for document preparation and review. On a straightforward deal, combined legal costs commonly run $5,000 to $15,000.
On a $2 million loan, total closing costs excluding the down payment can easily reach $30,000 to $60,000. These costs are sometimes rolled into the loan, but doing so increases your leverage and monthly payments.
Deducting the Interest
Mortgage interest paid on commercial real estate used in a trade or business is generally deductible as a business expense. Section 163(j) of the Internal Revenue Code limits the deduction for business interest expense to the sum of the business’s interest income, 30% of adjusted taxable income, and any floor plan financing interest. For tax years beginning after 2024, the calculation of adjusted taxable income was amended to allow taxpayers to add back depreciation, amortization, and depletion, making the limitation less restrictive than it had been in immediately prior years.
Real property businesses can make an irrevocable election to opt out of the Section 163(j) limitation entirely, which allows the deduction of all business interest without the 30% cap. The trade-off is that the real property must then be depreciated under the Alternative Depreciation System, which extends the recovery period for nonresidential property to 40 years instead of the standard 39. That slower depreciation reduces your annual deduction for the building itself. Whether the election makes sense depends on how much interest you carry relative to your depreciation deductions, and it’s worth modeling both scenarios with a tax advisor before committing.
What Happens If You Default
Default on a commercial mortgage triggers lender remedies that move faster and with less borrower protection than residential foreclosure. The lender can accelerate the debt, demanding immediate payment of the entire outstanding balance rather than just the missed payments. Unlike residential loans in some states, commercial borrowers generally have no statutory right to cure the default and reinstate the loan after acceleration.
If the borrower can’t pay, the lender forecloses on the property. In many states, the lender can also seek appointment of a receiver to manage the property and collect rents during foreclosure, preventing the borrower from letting the property deteriorate. After the sale, if proceeds don’t cover the outstanding debt plus fees and penalties, the lender can pursue a deficiency judgment on a recourse loan. On a non-recourse loan, recovery is limited to the property itself, subject to the carve-outs described above.
Commercial defaults rarely resolve in the borrower’s favor. A lender with a performing loan has reasons to work with you on modifications or extensions. A lender holding a defaulted loan has reasons to move quickly toward foreclosure. If you see financial stress on the horizon, the time to negotiate with your lender is before you miss a payment, not after.