Commercial and residential lending rate differential

By MARY HOLM

Q: In regard to property finance, why is it that commercial property finance is on average 2 per cent more than residential?

If one has a commercial property with a valuation of $200,000, and a lease agreement with a tenant paying $20,000 rental, with borrowing of $50,000, with such good security, why does one pay 2 per cent more than residential?

Are commercial borrowers subsidising residential?

Let's imagine they are.

We'll say that all borrowers should be charged the same interest rate. But lenders charge commercial borrowers 1 per cent more than the going rate, so that they can charge residential borrowers 1 per cent less.

Along comes Competitive New Lender. It decides to ignore residential borrowers, lending only to commercial borrowers, at the going rate.

With its 1 per cent advantage, CNL picks up all the commercial customers, and does very nicely, thank you.

Meanwhile, the other lenders are left with only residential customers, at below the going rate. Without the subsidy from commercial customers, they struggle to cover their costs.

They have to raise their residential rate or go out of business. And, if they want to regain any commercial business, they have to lower their rate for those customers.

These are the types of forces at work in markets all the time. People don't get away with overcharging, because somebody else can always undercut them.

The only reason this scenario hasn't happened - pushing commercial and residential rates to the same level - must be that there are higher costs and/or higher risks associated with commercial lending.

Given how many eager lenders there are out there, if you find that they all want to charge you more to buy a factory than a house, there must be a valid reason for it.


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