Long Term Commercial
Long Term CommercialCommercial real estate, abbreviated CRE, involves income-producing properties, retail outlets, shopping malls, and hotels. Conversely, residential real estate is homes. Special commercial real estate loans are used to acquire, develop, and construct a commercial property. Commercial real estate loans are supported by placing a lien on the property.
Banks and private lenders provide commercial real estate loans similar to how mortgage companies provide home mortgages. In addition to this, a commercial property can be purchased using the US small business administration 504 Loan program, private investors, pension funds, or insurance companies.
Individuals Versus Business Entities
A home mortgage is given to an individual to fund the purchase of a home. Conversely, commercial real estate loans are given to a business entity such as a corporation, a limited partnership, or a developer. Frequently, these business entities are developed with the sole purpose of finding and purchasing commercial real estate property.
A business entity that does not have a strong financial track record may be required to guarantee their loan with their business. This situation provides the bank or lending institution with a way to recover the debt if the business entity defaults on the loan.
If the lender does not require this type of guarantee, the commercial property will be used to guarantee the loan. This loan is referred to as a non-recourse loan, which means the only way the lender has to recover the money given for this loan is the foreclosed on the property and sell it in a foreclosure sale.
Understanding Loan Repayment Schedules
Residential mortgages are amortized loans, which means the loan will be paid off with regular payments over a specific amount of time. The most common residential mortgage is the 30-year fixed-rate mortgage. However, there are other options available for residential buyers, including 10 year, 15 year, and 25 year mortgages. A mortgage with a longer amortization provides the homeowner with smaller payments; however, the total interest on the loan is greater. Shorter amortization periods will have higher payments; however, the total interest will be less. A residential loan is amortized over the duration of the loan term, and at the end of the loan, the mortgage will be paid in full. For example, if an individual takes a $200,000 loan out for 30 years with an interest rate of 5%, they will make a total of 360 payments of $1,073.64 until the entire loan is paid off.
Commercial real estate mortgages are different. These mortgages are often limited to 5 the 20-year loan terms. A commercial real estate mortgage may run longer than the loan runs. For example, a lender may offer a commercial loan buyer with an amortization of 30 years; however, the loan must be paid off in 7 years. This means that during the first seven years, the investor must make payments monthly at the payment amount of a 30-year amortized loan. After the seven years, the remaining balance will be due in one final balloon payment.
If a commercial real estate investor borrows $1000000 add a new 7%, the monthly payment would be $6,653.20 for seven years. At the end of 7 years, $918,127 would be owed due and payable in a balloon payment.
A commercial real estate lender will determine the amortization period as well as the loan terms, including the interest rate and the number of years the investor has to pay on the loan before the balloon payment is due. Commercial real estate loan terms are based on the investor’s credit; therefore, the terms may be negotiable. If a longer loan repayment is desired, the interest rate will typically be higher.
Loan-to-value Ratios
Another critical difference between residential mortgages and commercial loans is the loan-to-value ratio, abbreviated LTV. The lender determines the LTV by dividing the amount of loan requested by the appraised value of the property or the price of the property. If the value of a commercial property is $100,000 and the loan is $90,000, the loan-to-value ratio would be 90%.
Both residential mortgages and commercial real estate loans that have lower loan-to-value ratios are eligible for better interest rates and terms than loans with higher loan-to-value ratios. The more equity a property has, the less risk a lender has.
Some residential mortgages are eligible for higher loan to value ratios. In fact, certain loans offer a 100% loan-to-value ratio like USDA loans or VA loans. The Federal Housing Administration ensures these loans for 96.5%. The remainder of these loans are guaranteed by Freddie Mac or Fannie Mae for 95%
Conversely, commercial real estate loans typically have a loan-to-value ratio between 65% and 80%. Although there are properties with higher loan-to-value ratios, it is not common. The top of Lone used will determine the loan-to-value ratio. For example, loans on vacant land may only be eligible for a 65% loan to value ratio loan. Multi-family construction loans may only be eligible for an 80% loan-to-value ratio.
The FHA or VA does not guarantee commercial real estate loans. Additionally, no private mortgage insurance is available, which means the lender is not protected if a borrower defaults. The lender can only recover money from the actual property if I was a fault occurs.
Private mortgage insurance, abbreviated PMI, is required insurance that protects the lender should the borrower be unable to have a sizeable down payment. If the borrower has less than 20% of the appraised value of the property to use as a down payment, the lender can reduce its risks by requiring the borrower to take out a private mortgage insurance policy from a PMI provider.
Debt Service Coverage Ratio
Commercial real estate loans usually have higher interest rates than Residential Mortgages. A commercial loan will also include other fees that are not charged on Residential Mortgages. These days can add considerable cost to the overall loan. Some of the common fees associated with commercial real estate loans include a loan application fee, and Appraisal, loan origination fees, and Survey fees.
Most of these calls must be paid upfront before the loan has been approved or rejected. For example, the loan may charge a 1% origination fee that is paid when the loan is closed. It may also charge another .25% annual fee until the loan is paid off.
Interest Rates and Fees
Another critical difference between residential mortgages and commercial loans is the loan-to-value ratio, abbreviated LTV. The lender determines the LTV by dividing the amount of loan requested by the appraised value of the property or the price of the property. If the value of a commercial property is $100,000 and the loan is $90,000, the loan-to-value ratio would be 90%.
Both residential mortgages and commercial real estate loans that have lower loan-to-value ratios are eligible for better interest rates and terms than loans with higher loan-to-value ratios. The more equity a property has, the less risk a lender has.
Some residential mortgages are eligible for higher loan to value ratios. In fact, certain loans offer a 100% loan-to-value ratio like USDA loans or VA loans. The Federal Housing Administration ensures these loans for 96.5%. The remainder of these loans are guaranteed by Freddie Mac or Fannie Mae for 95%
Conversely, commercial real estate loans typically have a loan-to-value ratio between 65% and 80%. Although there are properties with higher loan-to-value ratios, it is not common. The top of Lone used will determine the loan-to-value ratio. For example, loans on vacant land may only be eligible for a 65% loan to value ratio loan. Multi-family construction loans may only be eligible for an 80% loan-to-value ratio.
The FHA or VA does not guarantee commercial real estate loans. Additionally, no private mortgage insurance is available, which means the lender is not protected if a borrower defaults. The lender can only recover money from the actual property if I was a fault occurs.
Private mortgage insurance, abbreviated PMI, is required insurance that protects the lender should the borrower be unable to have a sizeable down payment. If the borrower has less than 20% of the appraised value of the property to use as a down payment, the lender can reduce its risks by requiring the borrower to take out a private mortgage insurance policy from a PMI provider.
Prepayment
Commercial real estate loans may have restrictions concerning prepayments. These restrictions are in place to preserve the lender’s profits from the loan. If the investor hopes to pay off the loan prior to the learn loan term coming to an end, they will be responsible for paying prepayment penalties. Here are the four different types of penalties that may be charged if you pay a commercial real estate loan off early.
Prepayment penalty
This penalty is calculated by multiplying the remaining debt by a specified penalty percentage.
Interest guarantee
The lender can charge a specific amount of Interest, which they are entitled to even if the investor wishes to pay the loan off early.
Lockout
Certain loans prevent investors from paying the loan off for a specific amount of time has passed. An example of this would be a 7 year lockout.
Defeasance
Defeasance acts as a stub substitute for collateral. Instead of paying the lender with cash, the investor will exchange the original collateral, the commercial real estate, with something new like US Treasury securities. Although this does reduce the fees associated with prepayment, just starting to agree, there are higher penalties attached to this type of loan payment.
The prepayment terms will be included in the investor’s loan documents and can be negotiated with commercial real estate loans.
The Bottom Line
When an investor purchases commercial real estate, he often Lisa’s the property out to collect rent from the business that wishes to operate there. This lease is used to provide a steady stream of income for the investor.
Lenders will consider several things when they evaluate the loan on a commercial piece of Real Estate, including the creditworthiness of the owner. The lender will require the investor to provide three to five years of financial statements and income tax returns. Finally, the lender will determine financial ratios and the DSCR of the property.