Commercial mortgages and residential home loans are both loans taken out on properties and they both use the property itself as collateral. What makes them different from each other? As a business owner, what do you need to know about making a commercial mortgage agreement?
While residential mortgages are usually between banks and individual buyers, commercial mortgages are made to a company or business. An individual could sign on to a commercial loan, but since the property is zoned for business use, for tax purposes, it is usually in the best interest of borrowers to sign as a representative of a business entity.
With a standard fixed-rate home loan, the balance and interest are typically amortized over the course of the loan. The payments will be consistent every month until the whole loan is paid off. A commercial loan, however, is characterized by a much shorter term (usually between 5 and 20 years compared with a 30-year home loan) and followed by a balloon payment at the end. So the loan has consistent monthly payments for the years of the term, with amortization based on a term longer than the loan like 30 years or so. That leaves a huge payment left at the end of the loan. The borrower can then repay the remaining balance, and refinance or sell the property.
Lenders determine how much to loan partly based on the loan-to-value (LTV) ratio of a property. For example, if a borrower is taking out a loan of $90,000 and the property has a value of $100,000, the LTV ratio is 90 percent. Residential mortgages allow much higher LTVs than commercial loans do. A typical residential home loan might have an LTV ratio of 80 percent, meaning the loan can only be 80 percent of the estimated value of the home. Since commercial mortgages are generally securing much more expensive properties, lenders usually have commercial LVT limits of between 55 percent and 70 percent. That means commercial borrowers have to come to the table with a lot more of their own money.
Commercial mortgage borrowers should be prepared to provide proof of business revenue and profits as well as a plan for how the commercial property will generate income. And of course, good credit scores will be essential for securing the loan at a good rate.