How Are Commercial Real Estate Loans Different Than Residential Loans?
Many borrowers and business owners are familiar, at least in theory, with obtaining a residential loan for a personal home. When it comes to commercial real estate loans, however, there is a great deal that must be learned in order to properly understand the differences between the two.
One of the major differences between a commercial real estate loan and a residential loan (often termed a mortgage) is who is responsible for the loan. For a residency, the loan is often granted to an individual, or a couple, who then bears the sole responsibility for repayment and management. With a commercial loan, however, it is usually a business entity that is responsible for the loan. This alleviates some of the pressure of such a loan from the individuals involved, but also might cause issues when it comes to determining eligibility. While credit history and assets are used to determine the worthiness of the borrower in both instances, a newly formed business entity is unlikely to have any sort of credit history at all. To remedy this, lending institutions will often use the credit worthiness of the individuals, even though the loan is not for their personal use. With a lack of credit history of a business, it is also quite possible that some sort of security or guarantee will need to be provided by the borrower.
Another key difference between commercial and residential loans is the way in which the loans are repaid. Again, it is not uncommon for a mortgage to be amortized and spread out over a fixed period of time. This allows the borrower to repay the loan in a predictable and stable manner, assuming that the percentage rate of interest of the loan is not variable. However, with commercial loans, the terms of repayment are often much shorter. In addition to this, they usually require a large balloon payment at the end of the payment term. For example, a business might have a loan that is to be paid in full after 10 years, but is amortized for a period of 20 years. This would mean that for 10 years, a business would pay the loan as if they were taking 20 years to pay it off. But after 10 years, the remaining balance would be due in one large payment. As with eligibility for the loan, both terms and interest rates are highly dependent upon the credit worthiness of the borrower.
Residential loans and commercial real estate loans also differ in how prepayment is handled, largely because of the highly adaptive way in which the terms are established. For the most part, the borrower is not penalized if a residential mortgage is paid off in advance, especially if such a clause is agreed upon before signing the paperwork. But this is often not the case with a commercial loan. Not only is there usually a prepayment penalty, if prepayment is even allowed at all, but many lenders also build in interest guarantees. This is a prepayment penalty where the lender is guaranteed a specific amount in interest, regardless of whether or not the loan is paid off early or goes to term.
Why are commercial real estate loans so different than residential loans?
Simply put, while both are designed for the acquisition and improvement of property, commercial real estate loans serve businesses that will eventually turn a profit on a regular basis. Because of this, the amounts are often significantly higher and the risk incurred by the bank is usually more severe.
This entry was posted on September 6, 2017 by bigdaddydennis3 in commercial lender and tagged commercial lending.commercial mortgage, commercial loan, commercial loans.