Understanding SOFR & Commercial Loan Floating-Rate Indexes: Term SOFR vs. Prime
Following the global retirement of LIBOR, the Secured Overnight Financing Rate (SOFR) has become the dominant floating-rate benchmark for commercial mortgages, bridge loans, and construction debt. Understanding how SOFR is measured, compounded, and paired with lender spreads is vital for managing commercial debt carry costs.
Indicative Underwriting Matrix
All floating-rate index comparisons and historical rate spreads are provided for educational purposes. Floating interest rates fluctuate daily based on Federal Reserve monetary policy and Treasury repo markets.
How SOFR Operates in Commercial Lending
The Secured Overnight Financing Rate (SOFR) is an empirical benchmark measuring the cost of borrowing cash overnight collateralized by U.S. Treasury securities. Because SOFR is anchored in an active, transparent market with over $1 trillion in daily transactions, it reflects true market liquidity without the manipulation vulnerabilities that plagued the defunct London Interbank Offered Rate (LIBOR).
In commercial loan documentation, floating rates are structured as: All-In Interest Rate = Benchmark Rate (e.g., 1-Month CME Term SOFR) + Lender Margin. For example, if 1-Month Term SOFR is 4.30% and the lender’s credit spread is 300 basis points (3.00%), the borrower’s all-in coupon for that monthly accrual period is 7.30%.
- 1-Month CME Term SOFR: A forward-looking projection of SOFR interest rates derived from trading in SOFR futures. Because it is known at the start of each monthly interest period, it allows borrowers to budget exact debt service amounts in advance.
- Daily Compounded SOFR: Calculated in arrears by compounding overnight rates over the accrual period. While mathematically precise, the exact monthly payment amount is only finalized a few days before payment is due.
- SOFR Floors: Commercial floating loan agreements almost universally include a "SOFR Floor" (typically between 1.00% and 3.00%), ensuring that the lender’s return never drops below a baseline if market rates decline dramatically.
Interest Rate Cap Requirements for Floating Commercial Debt
Whenever a commercial borrower secures a floating-rate bridge or construction loan, institutional lenders mandate the purchase of an Interest Rate Cap from an approved investment-grade financial institution (counterparty).
An interest rate cap is a derivative contract that acts as an insurance policy against runaway benchmark spikes. The contract specifies a "strike price" (e.g., 5.00% SOFR) and a term matching the initial loan maturity (e.g., 24 or 36 months). If SOFR rises above the strike price, the cap provider directly reimburses the lender for the excess interest, protecting the property from cash flow insolvency.
Frequently Answered Financing Questions
Verified answers to common borrower and broker inquiries regarding loan sizing, guidelines, and execution.
How does CME Term SOFR compare to the WSJ Prime Rate for commercial loans?
WSJ Prime is traditionally priced 300 basis points above the Fed Funds rate and moves in discrete 25-50 bps increments, whereas 1-Month Term SOFR fluctuates daily based on market repo transactions and typically trades 300 bps below Prime.
While small community banks often use WSJ Prime for commercial lines of credit, institutional debt funds, CMBS lenders, and regional banks prefer 1-Month Term SOFR for larger commercial mortgages.
Explore Floating-Rate Solutions →What is an interest rate cap replacement escrow in a commercial bridge loan?
An interest rate cap replacement escrow requires the borrower to make monthly cash deposits with the lender to fund the future purchase of a new rate cap when the initial cap expires at extension.
Because interest rate volatility can dramatically increase future cap option prices, lenders escrow funds monthly so that the borrower has sufficient liquidity to purchase required extension caps.
Consult Capital Advisory Desk →