What Are Commercial Loans?
A typical mortgage loan is a written contractual arrangement where a mortgage lender or private money investor lends funds to a mortgage loan borrower for a certain period of time and the mortgage loan borrower agrees to repay the terms of the mortgage loan amount timely and in full with accrued mortgage interest to the mortgage lender.
There are generally two types of real estate mortgage loans. Residential mortgage loans and commercial mortgage loans. Residential mortgage loans are normally for one to four unit owner occupied properties. Residential mortgages also includes second home financing and investment home financing up to four units. Any properties larger than 4 units is considered commercial properties and buyers of 4 plus unit properties needs to consult with a commercial mortgage lender to secure financing.
What Determines To Be Commercial Loans
Commercial Loans are loans used to purchase commercial properties such as multi-unit family housing greater than 4 units, strip malls, shopping centers, office buildings, warehouses, hotels, medical centers, gas stations, and other for-profit real estate where it generates cash flow.
Difference Between Residential Loans And Commercial Loans
The diference between a residential mortgage loan and a commercial mortgage loan is that commercial loans are processed and underwritten based on the income the property generates whereas with residential mortgage loans, the loans are processed and underwritten based on the credit and income of the borrower.
With commercial mortgage loans, the mortgage loan borrower’s income is not the main factor in a commercial loan approval. The commercial lender is primarily concerned with the income the commercial property generates based on income ratios and debt and profit and loss factors of the commercial property.
Risk Assessment On Commercial Properties
All commercial mortgage loans are underwritten based on risk based assssment. Each commercial mortgage lender views risks differently. The more risk a commercial mortgage underwriter see on the commercial mortgage loan, the higher the mortgage rates will be on the commercial mortgage loan.
Recourse Commercial Loans
Recourse commercial loans are commercial loans that require the guarantee of the borrower or borrowers. In the event of default on the terms and conditions of the commercial mortgage loan, the commercial mortgage lender can go after the guarantors of the commercial loan. If the commercial property forecloses and there is a deficit, the commercial lender can go after the personal assets of the recourse commercial loan borrower. With recourse commercial loans, the guarantor’s credit and income will be evaluated. The guarantor’s FICO credit scores will be looked at and the lower the guarantor’s FICO credit scores are, the higher the commercial mortgage rates will be.
Other factors that commercial mortgage underwriters will look at on recourse commercial loans is the guarantor’s reserves. The more reserves a commercial loan borrower has, the less risk the commercial lender has so the lower the commercial mortgage rates will be. Reserves are cash, stocks, bonds, IRA, 401k, and other liquidable assets.
Commercial Property Type
Another important factor commercial lenders will consider is the type of commercial property. Depending on the commercial mortgage lender, they normally have risk factors on the type of properties. Apartment Buildings are considered the most favorable and less risk. Gas stations will be considered the highest risk and therefore will have the highest interest rates and down payment requirements due to environmental issues such as oil and gas penetrating the soil and contaminating the land.
Income Assessment on Commercial Loans
The most important factor in underwriting a commercial loan is the income assessment and how much income the commercial property generates. For apartment buildings and apartment complexes, the gross scheduled rental income is extremely important
DCR/DSCR: Debt Coverage Ratio and Debt Service Coverage Ratio
A Debt Coverage Ratio of 1.0 means that for every one dollar of net income from the commercial property, you have one dollar in debt to be paid on the commercial property. It is net income divided by debt service. The higher the Debt Coverage Ratio is, the better it is and the more attractive it is for the commercial mortgage lender. Any Debt Coverage Ratio less than 1.0 DCR would mean that the property has negative cash flow. Most commercial mortgage lenders want to see a Debt Coverage Ratio of 1.2 or greater.