Running a new or established business? Strategic planning is crucial, but having enough working capital is equally important. Whether you're starting a new company or expanding an existing one, securing a commercial mortgage can provide the financial leeway you need.
In this comprehensive guide, we'll walk you through everything you need to know about commercial real estate loans. From understanding the terms and payment structure to exploring different financing options, this guide will help you navigate the world of commercial mortgages with ease.
Commercial Loan Terms and Payment Structure
Commercial mortgages have shorter terms compared to residential loans. Typically ranging from 3 to 25 years, these loans require borrowers to make a balloon payment at the end of the term. A balloon payment is a lump sum payment that pays off the remaining balance in the mortgage.
It's worth noting that some commercial loans offer interest-only payment options. This means borrowers only need to make interest payments throughout the term. However, at the end of the term, they must still make a balloon payment to settle the remaining balance.
Commercial Real Estate Interest Rates
Commercial loan rates are typically slightly higher than residential mortgage rates. They can range from 1.176% to 12%, depending on the property and financing type. The higher rates are due to the illiquid nature of commercial loans and the lack of organized secondary markets for them.
To determine commercial loan rates, lenders tie them to various indexes such as the prime rate, LIBOR (London Inter-Bank Offered Rate), U.S. Treasury Bonds, and swap spreads. These indexes provide an indication of market interest rates and help determine the interest charged on commercial loans.
Common Sources of Commercial Mortgage Financing
There are several sources of commercial financing available, including banks, credit unions, insurance companies, government-backed lenders, and private investors. The type of commercial loan you choose depends on your specific needs, business strategy, and credit availability.
Here are some common types of commercial loans and where you can find them:
Conventional Commercial Mortgages
Conventional commercial mortgages are provided by banks and credit unions. These loans are used for owner-occupied properties and investment properties. They typically require a personal guarantee and thorough underwriting, including an assessment of your global cash flow and financial statements.
Conduit or CMBS Loans
Conduit loans, also known as commercial mortgage-backed security (CMBS) loans, are backed by a first-position mortgage and are pooled together with other mortgages in a Real Estate Mortgage Investment Conduit (REMIC) trust. These loans are commonly used for properties like retail buildings, shopping malls, warehouses, offices, and hotels.
SBA Loans
The Small Business Administration (SBA) offers guaranteed commercial loans to qualified applicants. The SBA helps reduce default risk for lenders and provides easier access to capital for small business owners. There are two common types of SBA loans: the SBA 7(a) loan and the SBA 504 loan.
Hard Money Loans
Hard money loans are provided by private lenders and are often used by borrowers who have a history of foreclosure or short sales. These loans require sufficient equity as collateral and have shorter terms, typically ranging from 12 months to 2 years. Interest rates for hard money loans are usually higher than traditional commercial mortgages.
Bridge Loans
Bridge loans are similar to hard money loans but have longer terms, typically up to 3 years. The interest rates for bridge loans are slightly lower, ranging from 6% to 10%. Bridge loans are commonly used when transitioning between properties or during construction projects.
How to Qualify for Commercial Real Estate Loans
Qualifying for a commercial loan depends on your creditworthiness as a business owner. Lenders assess your credit score, down payment, business age, and other factors to determine your eligibility for a loan. Meeting the following requirements can increase your chances of approval:
Business Credit Score
Lenders evaluate your business credit score to determine the appropriate interest rate and down payment required for your loan.
Personal Credit Score
A high personal credit score is important for securing a commercial loan. Most lenders prefer a FICO score of at least 680, but aiming for a score of 700 or higher can increase your chances of approval.
Down Payment
Commercial lenders typically require a down payment of 20% to 50% of the property's value. Having a substantial down payment can improve your loan approval chances.
Your Company's Age
Lenders prefer businesses that have been in operation for at least two years. However, having an excellent credit history for both your business and personal finances can compensate for a younger company.
Occupying More Than Half of the Property
To qualify for a commercial mortgage, your business must occupy at least 51% of the property. If your business does not meet this requirement, you may need to pursue an investment property loan instead.
Factoring the Closing Costs
In addition to a down payment, you should also consider other expenses associated with closing a commercial loan. These costs can include appraisal fees, legal fees, title fees, and other transaction-related expenses.
Comparing Commercial Mortgages with Residential Loans
While there are similarities between commercial mortgages and residential loans, there are significant differences as well. Commercial loans typically require a stricter underwriting process, have higher costs and interest rates, and take longer to process compared to residential loans.
Here's a comparison between commercial loans and residential mortgages:
| Loan Details | Commercial Mortgage | Residential Mortgage |
|---|---|---|
| Borrower | Business entity | Individual borrower |
| Government sponsorship | SBA loans are backed by the government* | Conventional loans are backed by Freddie Mac and Fannie Mae |
| Payment terms | Short-term: 3-7 years | Long-term: 15 or 30 years |
| Interest rates and credit score | Based on creditworthiness and business profile | Credit score and government-backed programs |
| Loan-to-value ratio | 60% - 80% LTV | Varies by type of loan and government program |
| Down payment | Typically 20% - 30% | Varies, but average of 10% for conventional loans |
| Closing time | Longer than residential loans | 30-60 business days for conventional loans |
Useful Tips Before Applying for a Commercial Loan
Applying for a commercial loan can be overwhelming, but with proper research and preparation, you can find a loan that suits your needs. Here are some tips to keep in mind before obtaining a commercial loan:
- Research different lenders and loan programs to find the best fit for your business.
- Improve your personal and business credit scores before applying for a loan.
- Have a clear business plan and financial projections to demonstrate the viability of your business.
- Gather all the necessary documents, such as tax returns, financial statements, and business licenses.
- Be prepared for a lengthy underwriting process and potential delays in loan approval.
- Work with a trusted commercial mortgage broker or advisor to navigate the complexities of the loan application process.
The Takeaway
Commercial real estate loans are essential financing tools for businesses of all sizes. They provide the capital needed to acquire commercial property, avoid rising rental expenses, and lower overall cost structures. However, securing a commercial loan requires careful planning, thorough documentation, and meeting specific eligibility criteria.
By understanding the nuances of commercial mortgages, comparing loan options, and preparing your finances, you can increase your chances of obtaining the commercial loan that best suits your business needs. So take the time to research, assess your financial situation, and make an informed decision to propel your business to new heights.
