The Real Difference Between Commercial and Residential Real Estate Loans
Real estate investing is a popular venture for many entrepreneurs and it is good to know the difference between commercial and residential real estate, both in the types of buildings and the financing.
Residential and commercial real estate loans have a few key differences. Underwriting of the loans focuses on different things. Commercial mortgages focus on the property investment track record of the borrower, financials of the borrower plus their portfolio and property value based on market comp cap rate and income. Residential mortgages on the other hand focus on the local comps surrounding the home and the personal financials of the borrower.
Unlike residential mortgages, many commercial real estate loans come with penalties for prepayment. Expect to keep the loan through its maturity for a fixed rate. The additional percentage may not be worth the early payment. The amortization and terms of residential and commercial loans are very different. When the entire principal balance is paid, a residential loan is finished. However, the amortization schedule for a commercial loan is often listed as longer than the principal actually is due. Even if the amortization schedule states the current rate of payment pays the balance off in 25 years, the principal may be due in five years. Guarantors can choose to pay the full balance off themselves, by selling the property or refinancing the loan to pay off the principal balance.
A default on a residential loan can end in foreclosure and forfeiting the equity you put in the home. Many commercial loans come with recourse which is often much worse. Even if the bank seizes the home, recourse means you are still on the hook for the full principal amount. Often the investor must come up with the funds missing in their current equity in the property.
Commercial loans are often sought after a contract has been put on a property. A stark contrast to the pre-approval process residential loans require before purchasing a property. Instead of a pre-approval process, a term sheet is given to commercial real estate investors. The term sheet is based on the property’s financials. Being conservative with the financials given can ensure you don’t borrow more than the property can handle.
Commercial real estate is a viable investment opportunity. Understanding the differences between commercial and residential loans can aid in the process of obtaining financing for the property. For the financial savvy, it may even be a good idea to underwrite your own policy so you know what to expect.
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