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Remember, a commercial real estate loan is much different from a home loan no matter how identical it may appear phonetically. The most significant semantics of a commercial real estate or CRE as they call it in the industry is it is an income-producing property. It is used exclusively for business purpose rather than residential. Such properties include:
- Retail Malls
- Office buildings
- Shopping centers
- Hotels and
- Other commercial complexes
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Real estate financing can be for different purposes that includes acquisition, land development and construction. Ideally, commercial real estate loans are mortgages. They are secured by liens on the specific commercial property for which the loan is taken. However, you must have knowledge about the laws, the terms, the processes followed, the options available, the consequences of each option and all nuances that are involved in it.
All banks, as well as the independent lenders, make loans on commercial real estate just as they do for home mortgages. However, apart from the banks and independent lenders, you may also get the required capital from other sources such as:
- Insurance companies
- Private investors such as com
- Pension funds and even from
- The US Small Business Administration’s 504 Loan program
No matter whichever source you choose, a commercial real estate loan will have a significant difference from the residential loans in their characteristics, requirements, and others.
Individuals and entities
Typically, residential mortgages are made to individual borrowers while on the other hand a commercial real estate loan is usually made to business entities. These can be any one of the following:
- A corporation
- A developer
- A limited partnership
- Funds and
Sometimes, these entities are specially formed for the specific purpose of a commercial real estate. Therefore, an entity may not have any financial track record and hence no credit rating.
In this case, the lender will want the owners or the principals of the entity to provide a guarantee for the real estate loan. This guarantee will provide the lender with a credit history of an individual or a group of individuals. They will turn to then in case they have to recover their money due to loan default.
However, in a few cases such type of guaranty may not be required by the creditor. In such case the property is the only means to recover the money in case of loan default. Such type of real estate loan is called a non-recourse commercial real estate loan which means that the creditor will have no recourse against any owner of the entity or anything else apart from the property itself.
The repayment schedule
Every loan that you take no matter in what form, amount, or name you are legally obliged to pay it back along with interest according to a predetermined rate. This rate can be fixed or floating as per the policy of the lender.
However, it is not possible to repay the entire sum with interest the next month itself by any borrower. To provide some ease to the borrowers when it comes to repaying their loans, the lenders usually spread the entire sum due along with principal and interest for a specific period of time called the loan tenure. Accordingly, your payment for every month is determined. This is called the repayment schedule.
There is a difference in the structure of the repayment schedule for a residential and a commercial real estate loan as well.
For a residential mortgage
As for a residential mortgage, which is a type of amortized loan:
- The entire debt is repaid in equal installments over a specific period. The most common repayment schedule for this type of loans is a 30-year fixed rate mortgage. There are other options as well such as 25-year and 15-year mortgages.
- Longer amortization periods will typically involve smaller monthly payments but the total interest costs will be higher over the life of the loan as opposed to the shorter amortization periods.
- Ideally, residential loans are usually amortized over the life of the loan so that you can repay the entire loan amount by the end of the loan term.
For Commercial Real Estate Loans:
On the other hand, for the commercial real estate loans:
The repayment schedule usually ranges from five years or less to 20 years with the amortization period being often longer than the term of the actual loan. This is a complex thing to understand. Assuming that you take out a commercial loan for a term of seven years with an amortization period of 30 years, you will need to make payments for seven years with an amount that is based on the loan paid off over 30 years. This is followed by a single and final ‘balloon’ payment of the remaining balance on the loan.
This length of the loan term as well as the amortization period will have a significant effect on the cost of the loan. However, if you have a strong credit, you can negotiate on these terms. As is it is always, the longer the loan repayment schedule, the higher will be the rate of interest.
This is another aspect in that the commercial and residential real estate loans differ. Loan To Value ratio or LTV is a figure that measures the value of a loan you wish to take against the value of the property itself. A lender calculates LTV by dividing the loan amount by the lesser appraised value of the property or the purchase price.
For both commercial and residential real estate loans, lower LTVs will succeedin getting more favorable financing rates. The simple reason behind this is that it will have more equity in the property or stake that will lower the risk of the lender.
Commercial real estate loan LTVs usually fall within the range of 65% to 80% though rarely a few loans may have higher LTVs. This LTV usually depends on the category of the loan.
A commercial real estate loan will also differ from a home loan in terms of fees, debtservice coverage ratio, prepayment clauses, interest guarantee, lockout, and others.
Marina Thomas is a marketing and communication expert. She also serves as a content developer with many years of experience. She helps clients in long-term wealth plans. Marina has previously covered an extensive range of topics in her posts, including money saving, Budgeting, business debt consolidation, business, and start-ups.