Understanding the Fluctuations in Fixed Rate Loan Payments: What Factors Contribute to the Variability?

This is one very common question when new underwriters look at financials that show the monthly debt service payments. What they'll see is the amount can fluctuate a few thousand dollars a month.

Because of this fluctuation, they'll sometimes think that the loan is floating rate. The reason for the change is simply because the fixed rate loan is prorated on a daily basis. Febuary has 29 days, March has 31 days.

Example:

Say the annual debt service is $600,000 per year.

You'd think that this would equate to exactly $50,000 per month.

Since it's actually prorated on a daily basis, you'd take $600,000 / 365 = 1,644 Per Day

Then you multiply the $1,644 by the number of days.

February: $1,644 x 29 Days = $47,671

March: $1,644 x 31 Days = $50,959

Approximately $3,300 difference month to month in this example makes it understandable why people would think the loan is floating.

Why would it matter what the seller's financing is if you're getting new debt?

Seller motivation. If a seller has fixed rate debt and plenty time left on the term, you'll often see them list their property at a price that hits their projected returns to investors early. For instance, if they held the property for 4 years, they could list the property that achieves their 5 year return projection. If they don't get the price they want, no problem. They'll take it off the market and try again in 6 months or so. Two of my passive investment deals have done this.

In the case of floating rate debt, there could be a higher chance of a forced sale if interest rates increase. We saw this in the rate hikes of 2022-2024.

Note:

Some loan agreements actually do split the annual debt service into equal monthly payments. The norm on larger deals like 100 units and above is prorating on a daily basis.