Residential and commercial real estate loans vary in many important ways. Understanding the differences between these two types of mortgage loans can help you prepare more effectively for the commercial loan process. Here are some of the most important differences between commercial and residential mortgage loans for most borrowers.
Requirements
The most important factors considered by lenders when determining whether to make a residential mortgage loan typically include the income of the borrower, the amount of debt and the size of the down payment. While your personal and business history will have an impact on your ability to obtain a commercial mortgage, your lender will also look at the ability of the property to generate sufficient income to cover the mortgage payments and to turn a profit.
Lenders typically look for a debt coverage ratio of 1:1.25. This means that your property must generate enough income to cover its debts plus 25 percent for profits and operating costs.
Rates
Commercial mortgages are generally considered a higher-risk proposition by lenders. As a result, commercial loan rates are usually 2 to 2.5 percent higher than comparable residential mortgage rates.
The rates for both commercial and residential loans can also vary depending on the credit rating of the individual or business and on other factors that include the value of the property compared with the amount of the loan and the amount of the down payment. However, commercial loan rates will generally be higher than the interest rate paid by home buyers in the same area. Rates can also vary depending on the degree of risk perceived by the lender and the location of the property in question.
Repayment
In the residential real estate marketplace, the length of the repayment term for mortgages can range from 15 to 40 or even 50 years, with 30 years being the most common length. The higher risk assumed by lenders for commercial real estate transactions, however, means that you will likely be offered a much shorter repayment term for these acquisitions.
Along with a higher down payment requirement, you will usually receive a repayment term of 10 years or less for your commercial mortgage. Some loans are designed specifically for short-term investors and offer lower payments during the first part of the loan with a large balloon payment required at the end of the mortgage term.
Initial Costs
Home buyers with good credit can sometimes negotiate mortgages with very low or no down payment requirements. Private mortgage insurance payments and other costs may be assessed to borrowers who put less than 20 percent down on their home purchase.
Commercial mortgages are usually much less flexible regarding the amount of the down payment; you will likely be asked to put down at least 20 percent at the time of your purchase to achieve an 80 percent loan-to-value ratio. In a buyer’s market, however, commercial loans may be available to borrowers with only a 10 percent down payment.
Because commercial real estate mortgages are less regulated than comparable residential transactions, you may be able to negotiate more favorable terms with some lenders. This can provide you with added options when planning your next acquisition and can allow you to achieve your goals in the real estate marketplace.
