Commercial real estate is a property that produces income and is only used for business purposes. Some examples include office buildings, shops, hotels, and warehouses. If you plan to invest in it, you should understand that commercial real estate lending is quite different from a mortgage on your house. They can also be more difficult to get approved. Like mortgages, traditional lenders finance commercial real estate. Other sources can also provide capital, including private investors, pension funds, and insurance companies. Here are the main differences in how commercial loans differ from residential loans:

The Borrower

Unlike consumer loans, commercial loans are typically made to an entity. These can often be formed to invest in commercial real estate. Since the entity might not have a credit score or financials, personal documents may still be required at application.  

Commercial Loan Amount

You will be required to have immediate equity with a commercial loan. Loan-to-value (LTV) may be in the 60 to 80% range versus up to 100% on a personal mortgage. Commercial properties are riskier for lenders, so a lower LTV lessens the risk. Like consumer loans, a higher down payment will get you a more favorable interest rate.

Cost of Loan

Interest rates are typically higher in commercial real estate lending compared to residential loans. The fees charged are generally higher as well. They can be assessed upfront as an origination fee or built into the loan.

Loan Term

Thirty years is a common term for a residential home loan, but commercial loans typically are much shorter. The initial term could be for ten years but amortized over 30 years. A balloon payment would be due at the end of the 10-year term to pay off the loan, or the borrower would need to refinance. More examples of commercial loan terms.

Commercial Loan Prepay Penalties

Commercial loans can penalize the borrower for paying early since that decreases the lender’s revenue from funding the loan. The loan terms can even lock a borrower out of paying off the loan for a specific period. Be sure you understand any prepayment penalties before closing the loan.

Commercial properties are riskier ventures for lenders, so the terms will look quite different from residential loans. Lenders will want to evaluate the entity’s financial statements from the last several years to ensure repayment will be made as agreed. Recognizing how and why commercial loans differ from consumer loans is an important step before investing in a commercial property.