Commercial loans are quite
different than residential loans. Qualifying for a commercial loan has different
requirements and commercial lenders look at various aspects of the commercial
loan much differently than a residential mortgage underwriter looks at things.
Normally with commercial loans a larger down payment is required, the entire
process takes longer start to finish, and rates are typically higher as well for
commercial loans. The rest of the page will touch on a few topics regarding
Commercial Financing is underwritten on a case by case basis. Every loan application is unique and evaluated on its own merits, but there are a few common criteria lenders look for in commercial loan packages.
A key component in making an underwriting evaluation is the debt coverage ratio (DCR). The DCR is defined as the monthly debt compared to the net monthly income of the investment property in question.
Loan to Value
Most commercial lenders will require a minimum of 20% of the purchase price to be paid by the buyer. The remaining 80% can be in the form of a mortgage provided by either a bank or mortgage company.
For businesses less than three years old, personal credit of principals will be evaluated. This may hold true for longer periods of time for tightly held companies. For corporations, business performance and credit ratings will be evaluated with a proven track record.
Fair Market Value and Fair Market Rent will be analyzed. Special use property may require additional underwriting. Age, appearance, local market, location, and accessibility are some other factors considered.
Commercial Loans are required for apartment buildings above 4 units.
To calculate the debt service coverage ratio, simply divide the net operating income (NOI) by the mortgage payment(s). For the sake of simplicity, let us assume that there is only one mortgage on the property:
$500,000 First Mortgage
11% Interest, 30 years amortized
Annual Payment (Debt Service) = $57,139
DSCR = Net Operating Income (NOI) = $65,000
Total Debt Service $57,139
DSCR = 1.14
Most lenders will have a set Debt Coverage Ratio that they will want to see when considering underwriting the project. For example, retail property lenders may want to see a 1.3 DCR and an apartment lender may want to see a DCR of 1.2 or 1.25. The riskier the project, the higher the DCR.
There are several Lenders that will fund small commercial projects, similar to residential financing. Ask your Broker or Banker about these companies.
Depending on the market value and equity which you may have in your home or any other residential properties you may already own, it may be possible for you to refinance or obtain a second mortgage or HELOC to help cover all or part of a small to medium sized commercial real estate investment.
Unlike residential loans that are borrower and credit based, commercial lending is asset based, meaning that the loan is giving on the quality of the property and the cash flow potential of the property.
Aside from being generally more expensive than residential loans, commercial loans also take longer to close. Depending on the property and the scenario, you should allow a few more weeks for a commercial loan to close. So if you know that you need to get something done by a certain date, it is in your best interest to contact a mortgage professional as soon as you know what you want to do.
You want to make sure your property is free of any liens and to do this the title company will run a UCC search. When a person or company wishes to file a lien on commercial property there are different steps that have to be taken which are outlined in Article 9 of the UCC (Uniform Commercial Code). This search will find any liens that have been filed on the property.
Commercial loans are for the most part a little harder to get than a residential loan.
Commercial Loans have much more rigorous and often more expensive appraisal processes than residential loans.
Because higher loan amounts are often associated with Commercial Loans, some commercial lenders may require two appraisals from different certified appraisers if the loan amount exceeds a threshold limit. Certain lenders also require the service of their own approved appraisers.
Commercial properties are those other than a single family residence, 2-family, 3-family, or 4-family home. Properties that are 5 units or more, even though all units are of residential purposes, are considered commercial properties and require commercial financing. "Mixed-use" properties, those with a commercial unit and one or more residential units on the second/third floor, are also financed with commercial loans.
Appraising a commercial property is often more costly than appraising a residence of equal size
Another name for the Debt Coverage Ratio in the context of commercial mortgages is the Debt Service Coverage or Debt Service Coverage Ratio
It has a wide utility. It can be used for- extension of current business premises, funding property development, investment in residential and commercial properties, etc. It has a plus point, as the borrower can have an access to the mortgage, with minimal upfront payment. In this the preset mortgage schedules sanction greater flexibility, so the borrower can mould this type of mortgage as per the suitability.
The most important ratio to understand when making income property loans is the debt service coverage ratio. It equals Net Operating Income (NOI) divided by Total Debt Service.
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Information listed above is to be used for educational purposes only and is not guaranteed