When investing in commercial real estate, a buyer (often a business entity) makes the purchase, leases out space, and then collects rent from the tenants. The property is intended to generate income. A commercial loan is a type of debt-based funding arrangement that is typically used to finance significant capital investments and/or pay for ongoing operating expenses that the company might otherwise find difficult to afford.
Banks, independent lenders, insurance companies, pension funds, private investors, and other capital sources, such as the US Small Business Administration’s 504 Loan Program, make CRE loans available.
Commercial real estate loans are typically more expensive than residential loans. Read on to understand the points of difference between commercial loans and home loans.
Commercial Loans Vs Home Loans
Loans for commercial real estate are typically given to businesses (corporations, developers, limited partnerships, funds and trusts), while residential mortgages are granted to individual borrowers. Apart from that, the two differ in terms of repayment schedules and loan-to-value ratios.
Commercial loans typically have terms ranging from five years to twenty years, with the amortization period often being longer than the loan term. A lender, for example, might make a commercial loan for seven years with a 30-year amortization period. In this case, the investor would make seven years of payments based on the loan being paid off over 30 years, followed by a final “balloon” payment of the entire remaining loan balance.
Residential mortgages are a type of amortized loan in which the debt is paid back in regular installments over time. The 30-year fixed-rate mortgage is the most popular residential mortgage product. Residential buyers can also choose between 25-year and 15-year mortgages. Longer amortization periods are associated with lower monthly payments and higher total interest costs over the life of the loan, whereas shorter amortization periods are associated with higher monthly payments and lower total interest costs.
Residential loans are amortized over the loan term so that the loan is fully repaid at the end.
The Difference in Loan-To-Value Ratios
LTV compares the value of a loan to the value of a property. LTV is calculated by dividing the loan amount by the lesser of the appraised value or the purchase price of the property. Borrowers with lower LTVs will qualify for lower interest rates on residential as well as commercial loans than those with higher LTVs. The reason is that they have more equity (or a stake) in the property, which equals less risk in the lender’s eyes.
Loan-to-value ratios for commercial loans typically range from 65% to 80%. While higher LTV loans are possible, they are uncommon. The specific LTV is frequently determined by the loan category. In commercial lending, there are no VA or FHA programmes, nor is there private mortgage insurance. As a result, lenders lack insurance to cover borrower default and must rely on the collateralized real estate.
Certain residential mortgages, such as USDA or VA loans, allow for high loan-to-value ratios of up to 100%.
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