Opinion: As 2021-era loans reprice, borrowers have options

Micah Scott

Thousands of business owners and commercial real estate investors who locked in historically low borrowing costs during 2021 are now approaching an important financing milestone: the expiration of those fixed-rate terms.

As five-year loan periods begin to mature, many borrowers will soon face repricing in a very different rate environment than the one that existed during the pandemic. While interest rates have moderated from recent highs, they currently remain closer to long-term historical averages than pandemic-era lows, and are expected to increase in the near term. Pinpointing where they may move next remains difficult in a continuously shifting economic environment.

But for borrowers evaluating their options, the question is often less about where rates will go and more about how much certainty they want within their financing strategy. Rather than trying to predict future rate movements, some business owners and investors are exploring ways to create greater stability and visibility around borrowing costs.

One option worth considering is an interest rate swap, a financial tool that allows a borrower to convert a floating-rate loan into a fixed-rate obligation for a specific period. Swaps are flexible and can be structured for different lengths, depending on the borrower’s objectives and financial needs.

The borrower continues working with the bank that holds the original loan. Together, they determine the desired term and structure of the swap, most of which are established for periods of five years or longer. During that time, the borrower’s rate remains fixed regardless of how market interest rates move. When the swap term ends, the loan may reprice based on prevailing market conditions or continue according to the terms of the original loan agreement.

Because borrowing costs are established when the swap is executed, borrowers gain visibility into future debt-service expenses. This can simplify budgeting, cash-flow forecasting, capital planning and investment decisions – particularly when managing multiple priorities – and business owners and investors navigating changing market conditions can take some risk off the table by securing a fixed rate.

For those borrowers currently approaching the end of a fixed-rate period, a swap can also provide an opportunity to address refinancing risk before repricing occurs. Instead of reacting to future rate movements, borrowers can proactively evaluate whether securing a fixed borrowing cost aligns with their long-term financial strategy.

Another key benefit of a rate swap is the ability to secure a fixed rate for longer than five years. While 30-year fixed-rate mortgages are common in residential lending, banks are often reluctant to carry fixed rates beyond five years on commercial loans due to interest rate risk. Rate swaps help mitigate that risk for both parties, making it easier for banks to offer extended fixed-rate terms to commercial borrowers.

Interest rate swaps have been used for decades and remain among the most widely utilized risk-management tools in commercial finance. While they are sophisticated financial instruments and can be complex, borrowers do not need to navigate the process alone. The right banking partner will explain how a swap works, discuss potential benefits and considerations and help determine whether the strategy is appropriate for a specific situation.

Swaps can also be particularly attractive for borrowers who expect to hold a commercial property or investment asset for the long term. If ownership is expected to continue through the duration of the swap, the strategy can help support consistency in financing costs while reducing exposure to future rate volatility.

As with any financial product, it is important to understand the terms before moving forward. One key consideration is that terminating a swap before maturity may involve fees or costs, depending on market conditions and the structure of the agreement. Because these provisions can vary by institution and transaction, borrowers should discuss them with their banker and understand any obligations associated with an early exit.

While the future direction of interest rates will continue to evolve, borrowers have options for creating greater predictability within their financing strategy. An interest rate swap may not be the right solution for every situation, but its combination of rate stability, customizable terms and long-term planning benefits can make it a valuable tool for business owners and real estate investors.

Micah Scott is chief lending officer at OakStar Bank. He can be reached at mscott@oakstarbank.com.