Key Aspects of a Commercial Mortgage Loan
Evaluation of your Business Credit
Evaluation of the personal credit rating of an individual is relatively simple in comparison to evaluating the credit-worthiness of even a small business. In both cases, proof of income, assets and debts is required, but the business owner will need to supply more than just a few simple documents when applying for a commercial mortgage. In most situations, the personal credit rating of the business owner is not taken into account. However, the business must supply such documents as balance sheets, cash flow statements, and profit and loss statements, going back at least two years and often more. In addition, all of these documents must be prepared by a certified accountant, so unless you are a certified accountant it is not possible to prepare these documents yourself regardless of the size of your business.
In addition to an evaluation of the business, the property being purchased will also come under some scrutiny. The location and condition of the property, as well as the purpose of the business, and its past and projected revenue will all be evaluated. If the business that is purchasing the property is a new one, the lender may also require a business plan before agreeing to lend money for the purchase of the property. In cases where the purchase is intended to expand an existing business, a plan is not usually required.
Lenders View Commercial Mortgages as Risky
In the eyes of mortgage lenders, commercial mortgages have a much higher level of risk compared to a residential loan. For this reason, commercial mortgages typically carry higher interest rates. A commercial mortgage borrower can expect to be faced with an interest rate up to 2% higher than a comparable residential mortgage. Of course, as with a residential mortgage, the interest paid on a commercial mortgage is tax deductible, which provides some relief for the small business owner.
Another result of this higher level of risk is that commercial mortgages are typically available at much lower Loan to Value (LTV) ratios than are residential mortgages. The LTV ratio measures the size of the loan in comparison to the appraised value of the property. In the case of residential mortgages, the LTV ratio will often be above 80%--that is, the borrower’s mortgage is for more than 80% of the appraised value of the property. For commercial mortgages, the LTV ratio is usually between 55% and 70%. Certain mortgage lenders do offer loans with higher LTV ratios, but as with residential mortgages these carry higher risk for both the borrower and the lender, with higher rates of interest.
Terms and Conditions of Commercial Mortgages
Commercial mortgage terms are not quite the same as those for a standard residential mortgage. A conventional residential mortgage, such as a fixed-rate 30 year mortgage, involves monthly repayments that are fixed in size, and continue for the entire 30 year period. In contrast, the commercial mortgage more closely resembles a residential balloon mortgage in its structure and terms. Similar to a residential balloon mortgage, a commercial mortgage typically has a much shorter term. Monthly repayments are made on the commercial mortgage for a certain period of time specified in the mortgage contract. In most cases, repayments are made on a 30 year amortization schedule, even though the balloon payment will be due after ten or fifteen years. After the monthly repayment period ends the balloon payment is due, at which time the borrower has two options. They can pay the outstanding balance of the loan in full, or they can refinance the commercial mortgage.
Commercial mortgages are not only available in the fixed-rate variety. Adjustable rate commercial mortgages are also available, as well as convertible rate and capped rate mortgages. A convertible rate mortgage starts as an adjustable rate mortgage, but with the convertible mortgage type, the borrower has the option of locking in an interest rate at any time during the repayment schedule. The capped rate commercial mortgage also starts as an adjustable rate mortgage, and works in a similar fashion, with the advantage to the borrower of having a capped interest rate that can never go above a certain pre-determined level.
Refinancing a Commercial Mortgage
Just as a residential mortgage can be refinanced, a commercial mortgage can be refinanced also. In general, this is done when the balloon payment is due, rather than at any time before. Commercial mortgages are subject to penalties for early repayment, and the penalties are often much higher than for conventional residential mortgages.