Commercial Mortgage

Commercial mortgages can be used for a variety of purposes, including:

Financing the purchase the premises of a business
Extension or expansion of a current business
Commercial or residential real estate investment (including “house flipping”)
Commercial property development

Like a residential mortgage, commercial mortgages use the property as collateral for your loan. Commercial mortgages differ significantly from residential mortgages. From a borrower’s standpoint, commercial mortgages are used to finance office space, storefronts or other property that will be used primarily for business. A commercial mortgage is often taken on in addition to your residential mortgage, which means lenders will take your other liabilities into consideration.
With this in mind, commercial mortgages are much riskier for lenders. Aside from the U.S. Small Business Administration statistic that estimates that over half of all businesses fail within the first five years, it’s far more likely that a commercial mortgage borrower would default on his business loan before missing a payment on his home mortgage, if times were tight. Commercial mortgage lenders also scrutinize your business’s debt coverage ratio (DCR) - that is, the amount of income your business can make versus your company’s debt obligations - rather than your personal income. These factors create some key differences between a commercial and residential mortgage.

Higher Interest Rates and Penalties

As discussed above, commercial mortgages are riskier, and thus have higher interest rates than residential mortgages. Commercial mortgages also have steeper pre-payment penalties, given the more substantial costs and effort required to originate a commercial loan.

Lower Loan-to-Value Ratio

Whereas some homes can be purchased with 100 percent financing (i.e. the amount of the mortgage is equal to the value of the home), commercial mortgages require a larger down payment. How much the bank will lend you varies according to the property and business type, but typically, you won’t be able to land more than 75 percent of the value of the building in financing. To cover the additional costs, many business owners take out a home equity loan to make a down payment on their commercial mortgage.

Shorter Loan Terms

The standard home mortgage is 30 years, but most commercial mortgage terms are much shorter. Commercial mortgages are usually set up as balloon mortgages, wherein borrowers make monthly payments as if the mortgage were amortized for 30 years. However, after about three to seven years, the entire balance of the mortgage becomes due. At that time, the borrower must pay off the entire loan in a lump sum or refinance.

Conclusion

Commercial mortgages are necessary for funding business ventures. But given the increased risk and higher complexity, lenders will often charge you more in interest and penalties and impose stricter terms than with a residential mortgage. But on the bright side, the commercial lending market is highly competitive. Comparison shopping definitely pays off for commercial mortgages.