Some people may wonder “What is a commercial loan” and the answer to that is Farley simple. A commercial loan is simply a loan/mortgage that is made using a commercial real estate as the collateral.
All commercial loans are very similar to that of the more familiar residential loan/mortgage except the product type being secured by the loan is a commercial property. There are slight differences within the basic concept of commercial loans which differentiates itself from that of a residential mortgage. Loans for commercial properties are typically based on the performance of the property and the ability of the commercial building in questions to debt service, which means can the property fulfill the obligations of the loan, or in layman’s terms pay the mortgage, where as residential property loans mainly focus on that of the borrow and their credit worthiness.
Within the lending industry there are several different types of loan products to choose from depending on the borrowers needs, and the type of commercial property being purchased. When investors of commercial real estate are seeking to secure financing in the purchase of a property, one of the first decisions that must be made is whether the loan product is recourse, or non-recourse loan. A recourse loan is a loan in which the loan is secured by the property, and further more guaranteed by that of the borrower. Any deficiencies in the event of a default not only can the property be foreclosed on, but the borrower will be responsible for repaying the lender for any loss’s after the property is sold.
Whereas a non-recourse loan is structured using the property as the sole collateral and in the event the borrower defaults, the lender can take possession of the property immediately and will have no additional recourse against that of the borrower. Non-recourse loans are structured in this manner because traditionally commercial properties are placed in LLC’s, corporations, and other forms of vesting which protects the ownership group of the commercial property, and limits the amount of liability. In addition, by having a non-recourse loan in place, it allows the bank to recover the monies borrowed without having to deal with the potential risk of a borrower that is involved with bankruptcy proceedings, which in many states protects the borrowers from creditors such as the lender.
Traditionally commercial loans are much higher than that of the traditional residential loans. Commercial real estate values can range from a few million dollars well passed 100 million dollars depending on the asset being purchased. Majority of lending institutions provide commercial loans but the applicant seeking to borrow capital in order to purchase a commercial real estate investment must satisfy certain criteria in order to qualify for loans of such nature.
As discussed earlier, the primary criteria that all lending institution will determine during the course of evaluating a commercial property is whether the commercial building will be able to service the debt over the life of the loan. The Debt Coverage Ratio is the amount of cash the commercial property needs to generate in order to fulfill that requirement. In addition, due to the current state of the economy, and the lenders overwhelming desire to mitigate potential losses due to borrowers inability to service debt as we saw during the most recent housing market collapse, lenders are not only scrutinizing the viability of the commercial property but also that of the borrower.
In the past some lending intuitions may have overlooked the creditworthiness of a potential borrower if the commercial property was able to service the debt, but in today’s lending climate, the borrower’s credit rating, and cash on hand can be just as important a factor in securing a loan to purchase the commercial property as that of the commercial property in questions.
Long gone are the days of zero down payment loan products in the world of commercial real estate, and today lending institutions require some sort of down payment prior to providing the remainder of the loan proceeds needed to purchase a commercial property. Borrowers today, not only need to factor in whether the loan is a recourse, or non-recourse loan, but also need to determine what it will cost them out of pocket to purchase the commercial property. Borrowers and lenders alike will need to determine the “Loan To Value ration” or LTV which is the amount of money the borrower will need to put down in order for the bank to lend on the property, this is commonly known as the down payment.
If borrower it looking to purchase a commercial property at a price of $5,000,000 and the bank is requiring the borrower to put a down payment of $1,500,000, this tells us the bank is prepared to offer a 75% loan to value ration on the property.
The lenders decision on the amount of money required for the down payment will be determined by several factors involving both the commercial property and the borrower in question. The lender will take into account both current performance of the commercial property, and possible future profitability in order to insure that the property will be able to service the debt over the life of the loan. In addition the lender may impose certain restriction or reserve accounts to be put in place in order to mitigate any possible risks that might prevent the service of the debt.
In addition commercial loans tend to be a little bit more costly than that of residential loans, and that is because the amount of money needed by the borrower is much great than that of residential borrowers.
Traditionally commercial loans are fixed rate loans whether it be interest only, or interest and principle, the interest rate remains constant throughout the term/life of the loan. Commercial lending institutions typically lend on commercial real estate for shorter periods of time as well. Most residential lenders will loan on a particular home for upwards of 30 years whereas the traditional commercial loan is between 3-10 years, and only amortized over 30 years.
The different types of commercial loan programs available through lending institutions very but the core principles are relatively similar to that of residential loans, and factors such as interest rate, down payment, and term are used in both, and as one can see they are more alike than different.
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