What Is a Commercial Mortgage?

The broker on the other end of the line just quoted you 7.25% on a $1.4 million loan for a three-unit retail property. That is the moment a commercial mortgage stops being a definition and becomes a number you have to live with. So what is a commercial mortgage, exactly? It is a loan secured by a property used for business or income, where the underwriter cares less about your credit score and more about whether the building's income can carry the debt. That single shift, from personal credit to property cash flow, changes everything downstream: the rate, the term, the prepayment penalty, and what happens when the loan matures.

The first thing a newcomer gets wrong is assuming a commercial mortgage works like a home loan with a bigger price tag. It does not. A residential mortgage is priced on your personal credit score, your debt-to-income ratio, and the fact that you will live in the house. A commercial mortgage is priced on the property's net operating income and your balance sheet, meaning the lender wants to see that the rent covers the payment plus a cushion, usually a debt service coverage ratio of 1.25x or higher. That is why a borrower with excellent personal credit can still get turned down if the building's income is weak.

The term structure is where the two diverge hardest. You are not paying the loan off; you are renting the money for a few years and betting you can refinance when the balloon lands. That is the single biggest adjustment for anyone moving from residential to commercial. If you cannot refinance because the property value dropped or the bank tightened its credit policy, you are not in default on the monthly payment, you are in default on the entire balance.

Prepayment is another fault line. Residential loans let you pay off early with a modest fee or none at all. Commercial loans often carry a lockout period of two to three years where you cannot prepay at all, followed by a prepayment penalty that gets worse the earlier you leave. The penalty is either yield maintenance, a cash payment equal to the present value of the interest the lender loses, or defeasance, where you buy Treasury securities that replicate the remaining payments. CMBS loans, the securitized ones, almost always require defeasance, and it is rarely cheap. The practical takeaway: never sign a commercial mortgage without knowing the prepayment schedule in dollar terms, because selling the property in year three can cost you six figures.

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Conventional Bank Loans

The conventional bank loan is the workhorse. You will get a 5- to 10-year term, a 25- to 30-year amortization, and a rate that floats with the prime rate or the 10-year Treasury plus a spread. Credit unions are worth a call because they are member-owned and often underwrite to a 1.15x DSCR instead of the 1.25x the big banks demand, which can be the difference between a deal working and not. The catch is they rarely go above $1 million to $3 million, and they want a strong relationship, meaning your personal and business accounts.

SBA 504 and 7(a) Loans

For owner-occupied real estate, the Small Business Administration offers two programs. The SBA 504 loan provides a fixed rate set by the SBA's debenture rate, which is typically lower than a conventional bank's fixed rate, but the higher closing costs mean the effective rate can be higher over the first five years, so you must compare the all-in cost, not just the headline rate. The SBA 7(a) loan allows for a variable rate with a 25-year max term, a 10% to 20% equity minimum, and requires 51% owner-occupancy. Both programs are designed for small business owners, not investors, and the underwriting is thorough, so expect paperwork.

CMBS and Agency Loans

Fannie Mae and Freddie Mac buy multifamily loans from lenders, which means the underwriting follows their guides: a 1.25x DSCR minimum, a 75% to 80% LTV cap, and a prepayment penalty that is the greater of 1% or the present value of the remaining interest. These loans are non-recourse, like CMBS, but the rates are lower because the agencies have a government-sponsored guarantee. The rates are competitive, but the underwriting is slow and relationship-driven, and they rarely touch anything under $5 million. If you need speed or have a value-add deal, skip it.

Bridge Loans

Bridge loans are the short-term, high-rate option for a property that needs work or has vacant space. A bridge lender will give you 1 to 3 years of interest-only payments at a rate 200 to 400 basis points above a permanent loan, betting that you can fix the property, lease it up, and refinance into a permanent loan before the bridge matures. Bridge money is for experienced investors with a clear exit, not for first-timers learning on the job.

When you underwrite a commercial mortgage, the numbers that matter are not the ones you are used to from a residential loan. The debt service coverage ratio, or DSCR, is the first thing a lender checks. A 1.25x DSCR means the income covers the payment with a 25% cushion, and that is the floor for agency loans, though smaller banks and credit unions will often take 1.15x for loans under $1 million.

Interest rates on commercial mortgages are quoted as a spread over a benchmark, usually the 10-year Treasury for fixed rates or the prime rate for floating. The Mortgage Bankers Association publishes a quarterly average rate, and for Q2 2026 it was about 6.5% across all property types, but you should verify that figure against the MBA's latest release because it changes with every rate decision.

One detail that trips up first-timers is the interest calculation method. Most commercial loans use an actual/360 basis, which means you pay interest for the exact number of days in the month on a 360-day year.You take a 5-year bridge loan at 75% LTV with interest-only payments, planning to add value and refinance. The bank that was going to refinance you has tightened its credit policy and will not go above 75% LTV, so you need to bring cash to the table just to close the deal. You do not have it, so you miss the balloon payment, and the lender forecloses. The protection is simple: underwrite the exit, not the purchase. Know what the refinance LTV will be in five years, and do not rely on appreciation to save you.

If the normal refinance route is closed, your options are narrow. A bridge lender will extend the loan, but at a higher rate and a fee, which only pushes the problem down the road. The one move that often works is a sale-leaseback: sell the property to an investor and lease it back on a long-term lease, which frees up cash and gets the debt off your balance sheet. It is a drastic step, but it is better than a foreclosure on your credit.

The most expensive mistake you can make is believing a commercial mortgage is just a residential mortgage with a higher balance. It is not. The second misconception is that only big companies can get commercial mortgages. In reality, small investors and local business owners regularly take these loans for single-owner properties, and the SBA exists specifically to back them. It is not, because the all-in cost includes origination fees, appraisal, legal, and title, which can add 1% to 3% of the loan amount, and no one quotes that number.

Here is a fourth that is less obvious: the DSCR is not the only underwriting metric. A 1.25x DSCR can fail the debt yield test if the loan is large relative to the income. And the minimums vary: small banks and credit unions underwrite to a 1.15x to 1.20x DSCR for loans under $1 million, while the agencies hold the line at 1.25x. If a broker quotes you a rate without asking about the property's income, hang up.

The rate on a commercial mortgage is not a static number you can look up once and rely on. The Mortgage Bankers Association publishes a quarterly average, and the Q2 2026 figure was 6.5% across all property types, but that is a trailing average, not a quote. The all-in cost, which includes origination fees of 0.5% to 1.5%, an appraisal for $1,000 to $5,000, legal fees of $2,000 to $5,000, and title insurance, can add 1% to 3% of the loan amount to your effective rate. No lender quotes this number, so you have to ask.

The interest calculation method matters more than most borrowers realize. Actual/360, which is standard, charges interest for the exact number of days in each month, which is slightly more than a 30/360 calculation on the same rate.If you do not see it, ask why.

Outside the United States, the rules change. There is no global standard, so if you are buying cross-border, get a local broker who knows the market.

If you are reading this because you are about to price a commercial mortgage, stop and do three things. First, calculate the DSCR on the property using the actual rent roll and the actual proposed payment. If it does not hit that number at the rate you are being quoted, the deal is dead unless you are bringing more equity. Second, call three lenders, not one, and ask each for their minimum DSCR and their maximum LTV. The small players often underwrite to a 1.15x DSCR for loans under $1 million, which can make a marginal deal work. Third, ask for the prepayment penalty in dollar terms for every year of the loan, not just the first. A lockout period of 2 to 3 years is standard, but the penalty after that can be 5% of the balance, which is $50,000 on a $1 million loan. You need to know that number before you sign.

If you are refinancing an existing balloon that is coming due in the next 12 months, start the process now. Get your financials in order, fix any deferred maintenance on the property, and have a rent roll that shows stable occupancy. The lender is not lending on your potential, they are lending on the building's income, so make the building look as good on paper as it does in person.

And one more thing: do not believe the rate quote. A broker will tell you the rate, but the all-in cost includes fees, points, and the actual/360 calculation, and that is the number that matters. Ask for a loan estimate that breaks out every line item, and compare that across three lenders. The difference between a 6.5% and a 7.0% rate on a $1 million loan is $5,000 per year in interest, but the difference in fees can be substantial, so the cheapest rate is not always the cheapest loan.

Loan Type	Typical Use	Key Features
Bank/Credit Union	Small to mid-size investor, owner-occupied or small rental	5–10 yr term, 25–30 yr amortization, 1.15–1.25x DSCR, relationship-based
SBA 504	Owner-occupied real estate	Fixed rate, 20-yr term, 10% equity min, 3-yr prepayment penalty on loans >15 yr
SBA 7(a)	Real estate plus working capital	Variable rate, 25-yr max term, 10–20% equity min, 51% owner-occupancy required
CMBS	Large stabilized properties, non-recourse	Defeasance required, actual/360 interest, cash management controls
Fannie Mae/Freddie Mac	Multifamily 5+ units	1.25x DSCR min, 75–80% LTV, non-recourse, penalty = greater of 1% or PV of payments
Life Company	Stabilized Class A properties	30-yr amortization, slow underwriting, $5M+ minimum, relationship-driven
Bridge	Value-add or transitional properties	1–3 yr interest-only, high rate, needs clear exit plan