Now that you’re settled into your new abode and are feeling pretty pleased with yourself, next on your list of priorities is to fulfill your lifelong dream of being your own boss. If that dream job cannot take place using your house as home base, i.e. you must take the business out of the home, and into a building, or, if you are simply purchasing land upon which you will erect a particular building, the process for securing a loan for a business venture is way different than the one you endured for the purchase of your new home.
The procurement process is similar enough since commercial, as well as residential mortgages, essentially are loans procured through a bank or lending institution. Another factor which may be similar is whether or not you still carry student debt, as sometimes it can delay implementing the loan process. Don’t let the commercial loan procurement process thwart your attempt to fulfill a dream of owning your own business. The cumbersome details may be hard to grasp, so why not consider consulting with an expert, a commercial real estate lender who will help smooth out the loan process for you?
Applying for a commercial or residential mortgage
When applying for a commercial mortgage, as stated above, the mortgage is only applicable toward buildings (or land) in an area that is zoned for commercial uses. It is important to note the difference is zoning. For example, you cannot build a new home upon land that is zoned for commercial purposes; similarly, you cannot open up a business on land which is residentially zoned.
Repayment structures additionally vary as to commercial and residential mortgages.
For example, when applying for a typical residential mortgage, the steps would be as follows: 1) you accept the terms of the loan; and 2) you consent to repay the loan over a set amount of years.
Commercial mortgages differ because they have two components: 1) the amortization of the loan is the definition of what is used to calculate your monthly payment; and 2) the balloon payment is a period of time in which the borrower will decide to pay the outstanding balance in full, refinance the loan or sell the property.
Understand the commercial loan
To fully understand the ramifications of your commercial loan, try using a mortgage calculator to determine the terms which will be best for your new venture. Before simply jumping onto a website and realizing you don’t have the info at hand, you should first gather some pertinent financial information. You should know the value and zip code of the potential property, the current interest rates, your gross income and a list of your monthly debts. The more precise this financial data is, the more accurate your answers will be. If you choose to submit less-comprehensive data, you can simply use a feature on the mortgage calculator which has you “guesstimate” taxes and insurance based on plugging in your zip code. Using the latter calculation, you save yourself some work by allowing your computer to totally configure the calculation.
It is important to note that when depending on the online mortgage calculator, the information that is spit out after your financial data is inputted, is still a considered an estimate – nothing more. Therefore, use it as a general guide only in your mortgage procurement. There could potentially be some “wiggle room” present, given the disparity between different lenders and/or loan programs, and rates and terms.
During the application process, the lender must determine, after his or her evaluation of a business that has applied for a commercial real estate loan, if the property being considered to generate income may be compared to the debt on it. This is called the Debt Coverage Ratio, or DCR. A DCR of 1:1 means a property earns what it owes. Lenders like to see a DCR of 1:1.25.
Details of a residential loan
When you sit down face-to-face with the lender, the most-important criteria in his eyes will be your personal gross income and the amount of debt you owe. The lender will need to delve into your personal gross income and your current debt load. In general, a lender would prefer your debt is no more than 45% of your gross income. The mortgage payment alone should be must be below half of your gross income, usually around 45%. Your mortgage payment should encompass no more than 28% of your income.
The down payment for a residential loan is usually negotiable. If it is a strong housing market, you might even be able to obtain a get a zero-down mortgage if you have good credit. For example, if your loan-to-value ratio is more than 80%, i.e. the loan is more than 80% of the home’s current market value, you will need to pay private mortgage insurance (“PMI”).
A commercial mortgage is much riskier than a home mortgage, so, lenders generally require a 20% down payment and an 80% loan-to-value ratio. In a strong business climate, where lenders are competing for loan business, typically 10% down on commercial property is the general rule.
Terms: length of payment
A typical residential home loan has a 30-year term, but, it could be as short as 15 years, or stretched out to 40 years, and in a strong housing market, lenders will even offer a 50-year mortgage.
It is different, however, as to a commercial loan, primarily because it is considered risky. For a commercial loan, again because the risk is considered higher, typically the terms are for a 10-year payout, and business properties are often sold long, however, a 10-year payout is typical. As with residential mortgages, anything is negotiable, but business properties often are sold to long-term investors before the 10-year period is up.
While the typical residential loan can be paid off at any time, sans penalty, regardless of the length of payout, often residential loans are refinanced when the interest rates making this a cost-effect payment option.
Commercial real estate loans are subject to prepayment penalties
Hopefully, you’ve gained an understanding about the difference between commercial and residential mortgages and you can proceed with procuring a loan confidently and without issue.