Why Commercial Mortgage Rates Are Higher Than Residential

Ever wonder why businesses pay more for a mortgage on an office building than you do for your home? It’s not because lenders are being unfair. It’s because commercial loans carry more risk-and the numbers back that up.

Commercial loans are riskier for lenders

When you take out a mortgage for your house, the lender knows what to expect. You’ve got a steady paycheck, a credit score they can check, and a home that’s easy to sell if things go south. A commercial property? That’s a whole different ballgame.

Think about a small business owner who borrows $1.2 million for a retail space. Their ability to repay depends on whether customers keep walking in. If the economy dips, or a new competitor opens across the street, rent payments can drop fast. Unlike a homeowner who still pays their mortgage even after losing a job (because their home is their anchor), a business can collapse overnight. That’s why lenders demand higher interest to cover that uncertainty.

According to data from the Federal Reserve in 2024, the average default rate on commercial real estate loans was 2.7%-nearly triple the 0.9% rate for residential mortgages. That difference doesn’t come from luck. It comes from structure.

Loan terms are shorter and less stable

Most residential mortgages run for 15 to 30 years. Fixed rates. Predictable payments. Commercial loans? They’re often 5 to 10 years long, with balloon payments at the end. That means the borrower has to refinance or sell the property when the term ends.

Here’s the catch: if interest rates rise during that 7-year window, refinancing could cost 3% to 5% more than the original loan. And if the property’s value drops because the neighborhood changed or tenants left, the business owner might not qualify for new financing at all. Lenders know this. So they build that risk into the rate from day one.

Residential loans are designed for stability. Commercial loans are designed for flexibility-and flexibility costs more.

Down payments are bigger, but so are the stakes

You might need 5% to 10% down for a home. For a commercial property? It’s usually 20% to 30%. That sounds harsh, but it’s not just about the lender protecting themselves. It’s about aligning the borrower’s skin in the game.

When someone puts up 25% of their own money for a warehouse, they’re more likely to work harder to keep it full. They’re not just paying rent-they’re investing their savings, their reputation, their future. That’s good for lenders. But it also means the borrower has more to lose. If the business fails, they don’t just lose their monthly cash flow-they lose their life’s work.

Higher down payments reduce lender risk, but they don’t eliminate it. So lenders still charge higher rates to make up for the volatility of business income.

Property value is harder to predict

A three-bedroom house in a good neighborhood? Its value moves slowly, mostly with local housing trends. A strip mall? Its worth depends on who’s renting it, how long they’ve been there, and whether the zoning laws change.

Take a diner in a small town. If the owner retires and no one else wants to run it, the property could sit empty for months. Buyers won’t pay top dollar for a building with no tenant. That’s called “tenant risk,” and it’s a major factor in commercial appraisals.

Residential homes sell based on square footage, bedrooms, and curb appeal. Commercial properties sell based on cash flow. If the net operating income drops by 15%, the property’s value can drop by 25% or more. That kind of swing scares lenders. And scared lenders charge higher rates.

Regulations are looser for commercial loans

Home loans are tightly controlled. Lenders have to prove you can afford the payment. They check your income, debt-to-income ratio, credit history, and employment stability. There are federal rules-like the Ability-to-Repay rule-that force them to be careful.

Commercial loans? Not so much. There’s no federal requirement to verify a business’s income the same way. Many commercial loans are based on the property’s value and projected rent, not the borrower’s personal finances. That gives lenders less assurance. So they make up for it with higher interest.

It’s not that commercial borrowers are riskier people. It’s that the system gives lenders fewer tools to judge them reliably.

Market liquidity is lower

If you can’t pay your mortgage, the bank can sell your house quickly. There are thousands of buyers looking for homes every day. But if a business defaults on a loan for a medical office building, finding a buyer isn’t easy.

Commercial properties are niche. A dentist’s office isn’t useful to a restaurant owner. A warehouse with 20-foot ceilings won’t work for a boutique hotel. That means fewer buyers, longer sales cycles, and bigger losses if the lender has to foreclose.

Studies from the Urban Land Institute show commercial properties take 2.5 times longer to sell than homes during downturns. That delay costs lenders money. So they charge more upfront to cover potential losses.

Interest rates reflect the cost of capital

Lenders don’t just pull rates out of thin air. They borrow money themselves-from banks, investors, bond markets-to fund loans. Commercial loans are bundled and sold as commercial mortgage-backed securities (CMBS). These are seen as riskier than residential mortgage-backed securities (RMBS).

Because of that, investors demand a higher return on CMBS. That higher return gets passed down to borrowers. It’s a chain reaction: riskier assets → higher investor demands → higher loan rates.

In 2024, the average interest rate on a 5-year fixed commercial mortgage was 6.8%. The average for a 30-year fixed residential loan? 6.1%. That 0.7% difference might not sound like much-but on a $2 million loan, it’s $14,000 more per year.

What this means for business owners

If you’re planning to buy commercial property, higher rates aren’t a surprise. They’re the price of doing business. But that doesn’t mean you’re stuck paying more than you have to.

Here’s what helps:

• Strong tenant leases-long-term, creditworthy tenants lower your rate. A lease with a national chain like CVS or Starbucks can cut your rate by 1% or more.
• Higher down payment-putting down 30% instead of 20% can reduce your rate by 0.5% to 1%.
• Good credit-your personal credit score still matters, even for business loans. A score above 700 opens better terms.
• Shop around-banks, credit unions, and online lenders offer wildly different rates. Don’t take the first offer.

Commercial real estate isn’t a bad investment. It’s just more complex. The higher rate isn’t punishment. It’s insurance-for the lender, and for you.

What happens if rates drop?

When the Federal Reserve lowers rates, residential loans drop fast. Commercial loans? They follow-but slower. That’s because commercial lending depends on bond yields, not just the Fed’s rate. And bond markets react to economic signals, not just policy moves.

If you’re locked into a 5-year commercial loan at 7.2%, you won’t benefit from a rate cut until you refinance. That’s why many smart business owners build in a 10-year fixed rate-even if it costs more upfront. It gives them breathing room.

Bottom line: It’s not personal-it’s math

Commercial mortgage rates are higher because the system is built to protect lenders from unpredictable business outcomes. It’s not about who you are. It’s about what you’re borrowing for.

Residential loans are simple: a person, a house, a paycheck.

Commercial loans are complex: a business, a building, a market, a lease, a tenant, a cash flow.

That complexity costs money. But with the right strategy, you can turn that cost into a smart investment.