Learn How To Start Investing In Real Estate
Learn How To Start Investing In Real Estate

What You Need To Know Before Getting A Commercial Loan

Written by Paul Esajian

The longer you have been in the real estate business, the more opportunities that will present themselves. You may never know what the next deal will bring, but you had better hope you are ready to take it on. It doesn’t hurt to be able to work outside of your niche at times, especially when a great deal comes along. Just make sure you are comfortable making the transition.

Taking the leap from a single-family property to a multifamily is an experience in and of itself. However, going from a multifamily to a commercial property is like night and day. A commercial property, for those of you who may not already know, is anything with more than four units. This could be any property from a four-family mixed use to a large twenty unit apartment building. In addition to the obvious differences with property management and budgeting, the loan application process is completely different. If you are considering a commercial loan purchase, there are a few questions you need to ask before you get started. Here are the six most important things you need to know before getting a commercial loan:

What are the terms of the loan?

The terms for a single-family, owner occupied property and a commercial loan are completely different. For your primary residence, you can get away with putting as little as percent down, and still get a very competitive interest rate. On a commercial loan, you will most likely need anywhere from 25-30 percent down payment. This should be the first question you ask. Most of the down payment amounts are based off of your credit score. Even if you have a sterling score, you will still need a minimum of 25 percent down. There can also be a big difference in the terms of your loan. With a traditional single-family purchase, you will have the option of a thirty year fixed mortgage. On a commercial purchase, you may only be presented with a three, five or seven year adjustable rate option. Additionally, these rates will be much higher than what you see for a primary residence. The higher rate leads to a higher monthly payment, which will cut into cash flow. Before you do anything else ,you need to get a basic idea of the down payment and what terms are offered.

What are the costs of the loan?

The cost to obtain a commercial loan is much higher than any other type of loan. For a single-family home, you have an appraisal fee, loan origination and lender fees. On a commercial purchase, the appraisal fee is often three to four times higher. Your $450 fee can quickly turn into $1,200 or more, depending on the exact number of units. The $750 in lender fees can climb as high as one percent of the total loan amount. The time to underwrite the loan is much longer, which is one of the reasons why a commercial lender will charge more. There will also be increased attorney fees, environmental fees and title search charges that must be accounted for. All of this is on top of the property tax escrow, which is typically at least six months. Ask your broker if they can provide you with a good faith estimate.

What is the minimum loan amount?

Most single-family loans have a minimum loan size of anywhere from $50-75,000. Before you make an offer on a commercial property, you need to know if they have a minimum loan amount. The typical floor is anywhere between $100-150,000. Keep in mind that this is the loan size, and not the purchase price. If the lender requires a 25 percent down payment, the purchase price needs may need to be over $200,000. You also want to see if any property types are restricted by the lender.

Is there a prepayment penalty?

One of the issues that buyers had during the housing boom last decade was with prepayment penalties. They would receive short-term, adjustable rate loans, and try to refinance, only to be penalized. This would tack on thousands of dollars to the loan and make refinancing almost impossible. Changes to the loan application process make it impossible to close without being aware of a prepayment penalty, but they could still be out there. Commercial loans could offer a prepayment option that decreases every year you own the property. You may have no intention of selling or refinancing, but you need to know if you will have a prepayment penalty.

Do I need reserves?

You may think that your 25-30 percent down payment is enough to close. Even if you have a cushion for closing costs, it may not be enough to get approved. Some commercial lenders require that you have six months of the new mortgage payment in the bank for reserve purposes. Not only do you need this money, you may need it for a certain amount of time. Lenders are fairly strict on this. If they require it for six months, four months will not be close enough. You also need to know if they need this money liquid or if you can keep it in an existing account. The cash reserve requirements can make or break the transaction.

How long will it take to close?

If you have everything in order, you can close your primary home purchase anywhere from 30 to 45 days. For a commercial loan, you can expect to double or triple that time frame. The lender will need to review all of the leases on every unit, in addition to the rent rolls and any other information required. The appraisal process itself can take several weeks. The bottom line is that you will not be able to make an offer and close right away.

Commercial properties can be a great source of revenue. How they are underwritten and approved is completely different than your traditional loan products. Before you make an offer, you need to ask questions until you are comfortable with the process.