Commercial real estate loans are intended for businesses that would like to acquire real estate properties that they can earn revenues from. This is the most distinct difference between these loans and consumer mortgages. The latter is geared towards individuals who would like to acquire property for use primarily as an abode.
There are other differences between these two loans as well. These contrasts lie in the commercial real estate loan rates, the disbursal amount, the length of the terms, the lender’s rights in case of default, and their impact on personal credit scores.
They have Shorter Loan Terms
Most consumers are familiar with the term lengths of consumer mortgages. These loans are payable for up to 30 years with fixed monthly payments. One might assume that commercial real estate loans work the same way. However, commercial loans differ greatly from consumer real estate loans in this aspect.
In commercial real estate loans, businesses also receive an amortization period similar to consumer mortgages. However, they are required to repay a part of the loan in a shorter term. They will need to repay the remaining amount of the loan in one balloon payment when it matures.
For example, a businessman may take out a loan worth $125,000 with an annual interest rate of 7.5%, and amortization rate of 30 years, and a loan term of 120 months or 10 years. He’ll be paying $872.02 per month for 10 years with interest, and pay the remaining $108,493.67 at the end of the term.
They could Affect Personal Credit Scores
Lenders generally look at the business’ credit score rather than the owner’s rating. This is because the main source of repayment funds is the cash flow generated by the commercial property. However, borrowers may have to provide a personal guarantee to help settle the loan should the business default.
The business owner’s personal liability for the delinquent loan is determined by the 8 guarantee structures typically used in commercial real estate loans. Being personally liable for a loan that’s non-performing can negatively impact the proprietor’s personal credit score. It’s always a good idea for entrepreneurs to read the fine print and understand their liability exposure when applying for a commercial real estate loan.
Loan-to-Value Ratios are Lower
The loan-to-value ratio or LTV is a scheme that lenders use to calculate an applicant’s borrowing amount. The ratio represents a percentage of the property’s assessed value that the lender is willing to finance. This is similar to consumer mortgages, in which creditors forward up to 80% of the total value of the property.
Commercial loans involve much lower loan-to-value ratios. A borrower could get an LTV as low as 65%. This is, however, a benefit instead of a disadvantage. Having a lower loan-to-value ratio means that the business has more equity on the property and a lesser risk for the lender. This translates to relatively lower interest rates and manageable repayment terms.
Lenders generally look at the type of real estate that the borrower wants to finance when considering LTV ratios. However, commercial real estate LTVs don’t go beyond 80% unless the borrower is willing to shoulder higher interest rates.
They can have a Non-Recourse Option
The commercial real estate loan recognizes as a guarantee the property that it is financing. The lender automatically has a claim on the property in case the borrower defaults. In most cases, the issuer could also go after other assets owned by the debtor. This is the case in recourse commercial real estate loans. However, some commercial real estate loans could also be non-recourse by nature.
Non-recourse options mean that the lender can only go after the collateral that has been pledged to secure the loan. The financial institution could seize the financed property and auction it off to interested buyers. However, the lender cannot seize any other assets under the borrower’s name even if the property’s value after depreciation is not enough to cover the loan.
Non-recourse commercial loans can be difficult to qualify for. Borrowers will need to demonstrate the profitability of the business and the liquidity of their company’s assets. Their company must also possess a high credit score as well.
Commercial real estate loans come in handy when a business wants to add an income-generating property to its portfolio. Before taking out a loan, however, entrepreneurs should take the time to research and understand how these financial products work.
For instance, they should understand the differences between commercial and consumer mortgages. This is important because there are significant variations between the two in terms of the loan-to-value ratio, the loan term length, the borrower’s personal liability in case of default, and the actions the lender can take when the business fails to repay its obligations.
A thorough knowledge can help the business owner maximize the benefits of the loan to his business as well as avoid nasty surprises in the future. Familiarity can also help the proprietor make an informed decision before taking out a loan.
