The Difference Between Commercial and Residential Real Estate Loans
If you’re an experienced real estate investor, then you might think that you know everything that you need to know. What you might not recognize is that once you hit commercial real estate territory, commercial loans change. If you want to make sure that you get the best deal possible, you need to know the differences between a residential and commercial loan. Here are the main differences you need to be aware of.
Term and Amortization
With a residential loan, the loan finishes when you pay down the principal balance. For commercial mortgages, this isn’t the case. Instead, with commercial loans, you have less time to pay the full balance. In fact, you have less time than the amortization schedule. If you take out a 25-year loan, you are paying it at the rate that a 25-year loan would take but you don’t have 25 years. Instead, you have about five years. Generally, you pay it off by refinancing or selling the property.
Term Sheets and Pre-approvals
Residential lenders pre-approve you for a loan before you try to purchase the property. In commercial real estate mortgages, however, you put the property under contract and then look for financing. There is no pre-approval. You get a term sheet and this depends heavily on the financials of the property that you purchase.
With commercial loans, the lenders usually have prepayment penalties. If you decide to pay the loan off early, then you’re going to have an additional percentage on top of the remaining loan. You can’t simply pay the loan off early and have that be enough. When it comes to financing, you may want to consider choosing a loan that you are going to stick to throughout its lifespan, rather than prepaying. This way you can avoid any penalties.
If you buy a residential property but can’t pay the loan, then you may lose all of your equity and the house on top of it. With a commercial loan, however, the loan may involve recourse. This means that you could still be liable for the full loan amount. This is usually a lot larger than the equity portion that you own.
When it comes to commercial real estate, you have to approach the purchase differently than you would a residential mortgage. If you’re used to investing in residential real estate, it helps to understand the differences between the two before you take out a commercial loan.