Commercial real estate loans, adjustable-rate mortgages to rise

This May, a story published at internationalbanker. com carried with it this attention-grabbing headline: “Commercial Real Estate Loans: A Ticking Time Bomb for U.S. Banks.”

Any more news meant to turn heads?

Sure. For example, this headline from Fox News published July 1: “Many Americans with adjustable-rate mortgage loans about to face higher monthly payments.”

The Mortgage Dilemma

It seems that the honeymoon is over for millions of homeowners who opted for the allure of lower initial payments with adjustable-rate mortgages (ARMs). As interest rates started to climb post-pandemic, these same borrowers are now facing a stark reality: significantly higher monthly mortgage payments once their ARM re-sets.

Bloomberg reported that 1.7 million homeowners have purchased houses with adjustable- rate mortgages since 2019.

Many of them were “5/1” loans — a five-year mortgage set at a lower fixed interest rate, which initially sounds more attractive compared to a long-term fixed-rate mortgage (20- or 25-year loan), but then comes the catch: a mandated conversion to a market-based loan (mortgage) rate that is adjusted once (sometimes twice) a year.

Meaning, those people who signed their name to a fiveyear ARM when interest rates were still below 3 percent will see higher monthly payments on their loans in 2024 if they opt to re-new, as opposed to putting a “For Sale” sign out in the front yard. (Source: Fox News.).

Which means, claimed the same story, citing Bankrate and Newsweek, that with mortgage rates for a new fiveyear ARM hovering around 6.5 percent, homeowners who opt to buy a new ARM in 2024 could pay as much as $1,000 more per month for their mortgage.

At the epicenter of this financial rumble are those with those “5/1” ARMs.

“That’s why Lone Star National Bank (LSNB), for example, decided long ago that we were going to stick with fixed-rate mortgages,” said bank President S. David Deanda.

“An ARM may sound good to some homebuyers because they do initially offer a lower monthly mortgage payment; but when the Fed increases interest rates, those same people will end up having to pay a higher mortgage rate when they had no plans to do so initially.”

According to Forbes, after years of holding interest rates near zero despite signs of inflation, the Fed (Federal Reserve Board) suddenly started raising the rates.

For example, between March 17, 2022 and July 26, 2023, it raised its federal funds rates 11 times, from 0.25 percent to 5.5 percent. (Source: Forbes.)

That same rate currently sits in the neighborhood of 7 percent.

“That’s why Lone Star decided long ago to stick with fixedrate mortgages because in the end, we want to protect our customers; we want them to stick around,” said Deanda.

Still locally owned, one of the few still around, Lone Star opened for business in 1983 and has become one of the biggest regional banks in South Texas, which includes San Antonio, with total assets of approximately $2.9 billion.

“We have advised more than a few customers over the years that, yes, an adjustable-rate mortgage may sound good initially,” said Deanda, “with lower mortgage rates, but what’s going to happen when the Fed starts to increase its rates? How is the homebuyer going to handle higher mortgages for which they never initially planned?”

Immediately after the Great Recession of 2008, the Fed held interest rates near zero for approximately three years hoping to reinvigorate the economy; but even after that, the increases were incremental.

Then came March 2022, and the Fed rate increase kicked into gear, escalating rapidly, as the feds hoped that the higher interest rates would cool down the economy and the rate of inflation tied to it. At least with a 20-year fixed rate, or a 25-year fixed rate, you know you’re not going to get hit with unwelcome news five or 10 years down the road with regard to a higher monthly house payment, said Deanda.

“Yes, the cost of home insurance may increase, property taxes, too, but the mortgage payment, which is obviously the bulk of the monthly payment, is never going to change.”

Commercial Real Estate

The financial challenges of today isn’t solely confined to only residential homeowners. Commercial real estate borrowers are also bracing for impact. While home mortgages typically range from 20 to 25 years, most commercial real- estate (CRE) loans typically fall in the five-to-10-year range and are considered to be adjustable- rate loans.

Challenging news for some commercial real-estate investors who lack deep pockets.

Let’s say, the average strip retail or office center in Hidalgo County cost around $2.5 million when everything is said and done, said LSNB President Deanda.

“If the owner took out a loan five years ago at a rate of 4 percent, the monthly payment would be approximately $15,150,” he said.

“When the loan re-sets, say next month, the rate will be approximately 9 percent. Meaning, that the monthly loan payment for the same property will now be closer to $22,500 per month.”

So what can the property owner do but tell his or her tenants that the rent is going to increase when the lease renewal comes due?

For some, these are challenging times on multiple levels, said Deanda.

“For others, these are times that offer tremendous investment opportunities, for both homebuyers and commercial real-estate investors.”