What is an interest guarantee in a commercial mortgage?

What is an Interest Guarantee?

An Interest Guarantee in a commercial mortgage is a prepayment penalty ensuring the lender receives a minimum amount of interest, regardless of early loan repayment. This clause protects the lender's expected yield, particularly in scenarios where market conditions prompt borrowers to refinance. For borrowers, this means potentially significant prepayment costs if the loan is settled well before its maturity date.

How do Interest Guarantees Work?

Here's how an interest guarantee works on a typical loan:

  1. Guaranteed Interest Amount: The loan agreement specifies a minimum amount of interest that the borrower must pay, which is calculated based on a portion of the loan term or a set interest amount.
  2. Prepayment Scenario: If the borrower decides to pay off the loan early, they are required to pay not just the remaining principal but also the interest that would have been paid up to the guaranteed amount.
  3. Lender's Protection: This clause is a safeguard for the lender against losing anticipated interest income if market conditions change (like declining interest rates) and the borrower decides to refinance.
  4. Impact on Borrowers: For borrowers, an interest guarantee can mean a significant prepayment cost, especially if the loan is paid off much earlier than its maturity date.
  5. Common in Fixed-Rate Loans: Interest guarantees are often found in fixed-rate commercial loans, where the interest rate and payments are constant throughout the loan term.

This type of prepayment penalty ensures that the lender receives a certain return on their loan, regardless of the borrower’s actions, making it an important consideration in commercial mortgage agreements.

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