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Commercial vs. Residential Loans

Commercial vs. Residential Loans

It’s a common thought that purchasing commercial properties requires more money and more experience than purchasing a residential property, but that is not necessarily the case. Residential mortgages are usually given from banks to individual borrowers, either through dealing directly with the bank, lender, or mortgage broker. The loan is typically in the name of the individual and the finance terms are based on that individual’s personal ability to qualify. A commercial mortgage, on the other hand, is lent to a business based on the financials of that business and is usually in the name of a company since it is used for business purposes.

Qualifying for a residential mortgage requires the individual to provide two years of tax returns, proof of income, money to put down, usually between 3% and 20%, and requires the borrower to have a good credit score. Because the individual personally qualifies, residential mortgages tend to be less risky than commercial, giving the residential loan a lower interest rate and longer term.

Commercial loans usually are seen as higher risk, requiring more money to be put down (usually around 30%), with higher interest rates and shorter terms, but commercial lenders are more open to creative financing. So, while 30% may be required as a down payment, that 30% doesn’t necessarily have to come from you.

To qualify for a commercial loan, an investor or business is required to have a business plan, a good credit score, and the ability to show the property’s current or projected cash flow. While this is a little more intense and detail oriented, it can work to the investor’s advantage. If the property is already cash-flowing, that income can be counted towards the borrower’s income, to potentially help that investor qualify for the property.

One of the biggest things to be aware of is that the terms, conditions, restrictions, and penalties are very different between commercial and residential loans. Commercial lenders have the ability to customize a loan repayment schedule to each borrower’s needs or specific requirements. On the residential side, however, buyers usually finance their properties over a 15 or 30-year period, with fixed-rate mortgages. The longer time frame is ideal for homeowners because it provides a longer amortization period which in turn allows for smaller monthly payments, and usually lower interest rates. Commercial loans typically range from a shorter period, usually 5 - 20 years, with a higher interest rate, and the amortization period is often longer than the loan term. The difficulty with this is that sometimes, although the amortization period is longer, the remaining amount can come due all at once, which can be harmful to uneducated investors who may not fully understand how commercial loan terms work.

Areas of Review

Takeaway

Big picture takeaway points

  1. Commercial loans usually are seen as higher risk.
  2. Residential mortgage requires the individual to provide two years of tax returns, proof of income, money to put down, usually between 3% and 20%, and requires the borrower to have a good credit score.
  3. Depending on how you will structure your deals, there is a vast difference in commercial and residential loans.

Reflection

Self-reflection questions to think more about the content

  1. Do I have an education or knowledge on how to structure or qualify for a commercial loan?
  2. Am I ready to move forward? When you are ready to invest in commercial property, do you have a power team that can help with this deal?
  3. Do I have all my documents ready for review?

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