Commercial Mortgages

Commercial Mortgages

Applying for Commercial Real Estate Loans

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Looking to expand your business, or just to stop paying rent every month? Commercial real estate loans can get you into a new position as a property owner. Here are some important facts to keep in mind as you consider applying for commercial real estate loans.

The most important lesson is to unlearn what you know about residential mortgages. Lenders require different types of information, rates change in different ways, and lending requirements vary as well. Make sure you take the time to understand exactly how commercial real estate loans work before you start talking to lenders.

There are Several Different Types of Real Estate Loans

Fixed mortgage is the most common commercial mortgage. Fixed mortgages have consistent payments throughout their term. The upside is if interest rates increase, your rate and payment remain the same. However, if interest rates fall, you remain at the higher rate.

Adjustable rate mortgage rise and fall with the times. They are a gamble. Many investors have entered into adjustable rate mortgages that they could easily afford. However, when rates increased and their payments increased, they had problems paying the higher rate and wound up in default. As a general rule the opening rate for an adjustable contract will be less than the fixed rate which makes the gamble somewhat attractive.

Interest only mortgage allows the purchaser to buy more than he could conceivably purchase on a conventional fixed mortgage. These are written for a specific time frame. At the end of the contract a balloon payment is expected for the original purchase price. In this case no equity has been established because payments of interest only were made. If the property or asset has increased in value giving the purchaser the necessary equity, this would be an opportune time to either sell the asset or convert to a fixed rate commercial loan.

Commercial real estate loan requirements

For the first-time borrower it is important to know that lenders prefer owner-occupied premises. What this means to you is if you are purchasing an apartment building, you will be living there. If you are buying an office building or complex, you will be operating out of one of the offices. If you are building a warehouse it is for your company's use.

To evaluate your business as a credit risk, commercial lenders will do an in-depth analysis of your business's financial health. You'll have to provide:

While it's not usually part of the evaluation, you may also have to provide your personal financial records.

It will be in your favor if the very important documents like financials, profit and loss statements, and balance sheets have been prepared by an outside accounting service..

These documents go into the calculation of your debt service coverage ratio (DSCR) - the ratio of your net income to the monthly mortgage payments. You'll have to demonstrate a DSCR of at least 1.25 - that is, that your income exceeds the expected payments by 25% - to get the best rates.

Unlike residential mortgages, you won't be able to borrow the entire purchase price of the property: commercial real estate loans aren't available with zero down -payment. The ratio of what you borrow to the value of the property is referred to as LTV (loan to value), and the lower that ratio, the better rate you're likely to get on your mortgage. Many lenders cap the LTV at 75%, and you'll get better rates at an LTV of 50% or 60%.

Getting approved for a commercial real estate loan

Even if you meet the basic LTV and DSCR ratios, the type of loan you're applying for can also impact your chances of being approved. Buying a property with the intent to lease it can be difficult, especially if you don't have any previous experience managing commercial properties. Unless you're buying a property that has existing tenants, you won't be able to use the future rental income as part of your application.

Restaurants and nightclubs may also face difficulties securing a commercial real estate loans, due to the high rate of failure of new locations. And individuals just starting out in business are unlikely to get a commercial mortgage no matter what their business plan or financial situation: businesses without a proven track record are considered very poor risks by most lenders.

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