Welcome to the Banker’s Terms section of DoctorEquity’s blog. I want you to put the best foot forward when talking to your banker. Knowing the same language makes you look like you actually know what you are doing.
Term is a simple term. It’s how long the mortgage goes before it matures. Maturity is the date that the lendee (person getting the loan) must pay back all the remaining principal. We don’t think about term too much when we do an amortization, like we do with our primary residence. We just think that we have a 30-year loan. This type of loan is amortized over 30 years, meaning it goes to zero principal after 30 years. The loan never needs to be paid off until the end of the 30 years, so the term is also 30 years.
When shopping for commercial loans, the term can get a little more complicated. Banks are aware that the prime interest rate will change over the course of time. They would prefer to not be locked into a lower rate where they make less money in interest. They would like to renegotiate the loan at a certain interval, so they bake it into the mortgage contract with a term that is shorter than the amortization.
A commercial loan will commonly have 20-year amortization, which is then used to calculate the monthly payment amounts. The bank will then set a 5 year term or some other negotiable time frame, with which the remaining principal needs to be paid off. After 5 years, you need to pay off the loan. This is scary, but in practice, you usually go back to the bank and negotiate terms on a new loan. You will amortize the new loan, set a new term, and the bank gets a fee in closing costs again. Very nice for the bank.
It is beneficial to you to maximize the term whenever possible. You always have the option to pay it off whenever you want, but this prevents the mortgage from becoming due and causing you a headache in refinancing. Use the term as a point of negotiation when dealing with your bank.
