Commercial Real Estate Mortgages are So Different from Residential
Traditional commercial real estate mortgages are set up quite differently than residential.
When you understand the differences and why they exist, you’ll find your interaction with commercial lenders to be much easier.
In fact, you’ll be in a position to…
- Negotiate better terms for yourself
- Save money on interest and
- Decrease future financing headaches
Here’s…
Your Questions
Why are commercial real estate mortgages structured differently than residential?
What are the major features of commercial real estate mortgages?
Can you overcome any of the built in disadvantages?
Real Answers
Why are commercial real estate mortgages structured differently than residential?
The U.S. government has only one means of backing commercial real estate mortgages. That is through the SBA 504 and SBA 7a programs.
Conversely, residential lenders have their mortgages federally backed by companies like Fannie Mae and Freddie Mac.
But to qualify for government backed SBA loans, you must…
- Be a very strong borrower
- Be the owner(s) of the business
- Be operating the business from the property being financing
You can’t get an SBA loan on apartment buildings for example.
Since the government won’t back most commercial loans, lenders and banks have to keep the loans on their own books. In effect, the risk to them is much higher.
Lenders just can’t afford to have a number of commercial loans going bad. Because of this increased risk, commercial real estate mortgages are…
- More difficult to qualify for
- Structured to protect lenders
- Structured to be paid off sooner
- Structured to guarantee interest
There’s only one problem though. These features are not designed to benefit you - the borrower.
What are the major features of commercial real estate mortgages?
&
Can you overcome any of the built in disadvantages?
Here’s a comparison of the features of residential mortgages versus commercial mortgages…
| Features | Residential | Commercial |
|---|---|---|
| Credit requirements | Personal Credit | Personal and/or Business Credit |
| Turnaround Times | Close within 30 days | 45 to 90 days or more |
| Length of term | 30 Years | 15 - 25 Years |
| Early Payoff | Not required | Balloon due in 5 years |
| Prepayment Penalty | No penalty | Penalties up to the 1st 10 years |
| Interest Rates | Based on few factors | Based on many factors |
Credit Requirements – Personal and/or Business Credit
Because of the increased risk, they’ll scrutinize your personal and business credit report.
If you haven’t began to build business credit yet, it would be wise to get started as soon as possible. In the meantime, they’ll rely on your personal credit scores and reports.
If your business credit is good, you’ll stand a better chance of qualifying. Still, they’ll want to make sure you have no bankruptcies or foreclosures on your personal credit report.
Turn-Around Times – 45 to 90 days or more
Commercial loans take so long for a few reasons…
- Most commercial lenders have a linear loan process
- Loans may sit in “committee” for weeks and weeks on end
- 3rd party reports that are required – appraisal, environmental, title, etc.
- Borrowers don’t submit all of the documentation requested in a timely manner
While some of this is out of your control, you can do much to expedite the process.
If you turn in the documents requested in a timely manner, not only will lenders have all that they need to process your file, but they’ll also be impressed.
You’ll stand above the crowd as a borrower that deserved their immediate attention!
Length of Term - 15 to 25 years
They’ll get their money back faster with these shorter terms.
While this may decrease your ability to get the highest possible loan amount, this may still serve you. How?
Since more is being applied to the principal, each payment actually saves you money on the interest.
But if you want to maximize your borrowing power and loan amount, request a 30 year term.
Some lenders will provide them while others won’t. To find lenders who do have 30 year terms, feel free to Contact Us and we'll assign you one right away.
Early Payoff – Balloon Due in 5 Years
A 5 year balloon payment is when the entire loan amount becomes due and payable in full after the first 5 years of the loan. Lenders get may get their money back sooner but borrowers end up carrying a heavy burden.
The due date comes quickly. Before you know it, 5 years is up and you’re forced to refinance or sell in order to pay off the mortgage. Now you’ll have to go through the entire process all over again!
Who wants to deal with that?
Wouldn’t you prefer a commercial mortgage with no balloon at all? That way you get to choose if and when you want to refinance.
Why not talk to your banker about it. If they don’t have a balloon free product that suits you, Contact Us.
Prepayment Penalty – Penalties Up to the First 10 Years
While paying early decreases the amount of interest you pay, it also decreases their profits. So, they don’t want you to make any early payments. Prepayment penalties are intended discourage you from pre-paying.
You’ll want to negotiate the lowest and shortest possible pre-pay penalties. Always shoot for no penalties at all. But if you have no choice, try to get a very soft prepayment penalty.
Maybe one where they let you pay up to 20% of the principal every year without penalty, for example.
This is a nice soft pre-pay because you can pay 20% down every year and have the property paid off within 5 years without penalty if you so choose.
If your local lender won’t give you a soft pre-pay, Contact Us.
Interest Rates – Based on Many Factors
While residential loan rates are determined by your credit score and LTV, commercial rates are based on so many different factors like…
- Your credit
- The property type
- Loan amount
- LTV
- Length of term and etc.
To get the best interest rate, don’t fret about the interest rate.
What?
Yep. That’s what I said. Instead, focus on how you can…
- Improve your personal and business credit scores
- Improve the flow of cash in your business and/or commercial property
- Consider a lower loan amount with a shorter term
- Get a soft pre-payment penalty so you can save interest by paying early if you want to.
When you do these things, you won’t have to fret about the interest rate at all.
Instead, you’ll find lenders knocking on your door begging you to do business with them ;-).
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