When financing a commercial real estate purchase, the devil finds its way into the details in surprising ways. One of the details that can provide a fair amount of headache for developers and investors is the decision to choose either a fixed or a floating mortgage rate. There are, obviously, risks and rewards to each, and there may be times when the safest bet isn't always the best one.

Fixed-rate mortgages are the most risk-averse bet, so the analysis will begin there. The obvious benefit to a fixed-rate mortgage is the lack of volatility. If the borrower is comfortable with the rate, he or she can just lock in for the holding period and enjoy stress-free stable cash flows, shifting the risk of rising interest rates to the lender. Many fixed-rate mortgages are non-recourse as well, keeping personal liability for the borrower at bay. The disadvantages to fixed-rate mortgages begin with the rate - fixed-rate mortgages start at higher rates than introductory floating-rate mortgages. Also, fixed-rate mortgages often carry a yield maintenance provision that will impose substantial penalties on the borrower if the mortgage is paid before it reaches maturity, i.e., a pre-payment penalty. Some mortgages, however, contain an assumption clause that will allow a new buyer to assume the debt (as long as the lender approves), thus mitigating the factor of a prepayment penalty.

Floating-rate mortgages were vilified in the past as a sign of irresponsible borrowing, but they are, like any investment vehicle, a calculated risk. First of all, the lower introductory interest rate discussed above is a result of the age-old financial wisdom that added risk should be accompanied by added reward. In addition to a lower initial interest rate, another benefit of a floating-rate mortgage is flexibility - investors planning to only hold the property for a short term can do so safely without fear of a prepayment penalty. Not every commercial borrower looks to be a long-term holder - properties that are ripe for quick sale or refinance within the first few years of ownership benefit from the lack of prepayment penalties on floating-rate loans. The obvious downside to a floating-rate mortgage is the assumption of the risk that interest rates could rise. Seasoned borrowers with a high tolerance for risk and a sense of where rates might be headed can capitalize on low rates using floating-rate mortgages. These borrowers should carefully consider whether they can absorb the potential losses due to rising rates.

The bottom line is that floating-rate mortgages aren't entirely anathema anymore, and fixed-rate mortgages have drawbacks despite their stability. Commercial real estate borrowers should consider stability, flexibility, and above all, risk in considering whether a fixed or a floating interest rate is right for their commercial real estate mortgage.