A commercial mortgage is a mortgage taken out on a property that is to be used for commercial purposes and not personal or residential. Commercial purposes include businesses, corporations, partnerships, etc. In commercial mortgages, the commercial property serves as collateral for the duration of the loan. The loan is paid back over an agreed period in installments.
Acquiring and paying off commercial mortgages can require a slightly more complicated process than traditional mortgages. Commercial mortgages also come with a different set of risks than traditional mortgages. That is why a comprehensive understanding of commercial mortgages is important before applying for one.
Features of Commercial Mortgages
There are several types of commercial mortgages that a business can apply for, depending on the mortgage lender, down payment, and many other factors. Across all types of commercial mortgages, some critical features remain relevant. These include:
These can be fixed, variable, or combined. Interest rates are usually presented as a percentage of the initial loan price.
Also known as the amortization period, this refers to the amount of time stipulated for the loan to be paid back. An average commercial mortgage can have an amortization period of 1-25 years.
This is a percentage that shows the ratio of the loan amount to the market value of the property being mortgaged. Lenders use this value as a determiner for the amount of risk they would be taking on by approving a loan.
Differences Between Commercial and Residential Mortgages
Residential mortgages are the more popular type of loan among the two. Customers familiar with residential loans may feel like there is little to no difference between residential and commercial mortgages but this is not true. Some key differences include:
On average, commercial mortgages often require larger down payments than residential. Where a residential property loan may require a down payment of up to 25%, industrial properties may require up to a 35% down payment.
The requirements for residential loans include personal income, expenses, and credit scores. For commercial loans, the requirements are more specific and may be determined by the property that is being mortgaged.
Most commercial mortgages require higher interest rates as commercial properties often have higher values than residential ones. This incurs more risk for the lender. The interest rate may also increase due to the revenue being made by the business or its credit score.
Besides the down payment and interest rates, commercial mortgages cost more than residential due to processing costs. These processing costs are higher because commercial mortgages require more paperwork and time, documents like environmental reports and property appraisals cost more.
Commercial mortgages typically require longer processing times than residential mortgages. Where a residential mortgage can take as little as four weeks to be approved and closed, a commercial mortgage could take anywhere from a month to a year.
Requirements for Commercial Mortgages
There are certain criteria that a business must pass before being approved for a commercial mortgage. Some of these requirements are explained below.
The business that is applying for the loan must present a feasible and profitable business plan for its operations. A business that does not seem profitable is not likely to be considered for a mortgage. Lenders have to ensure that the business will make enough income to cover pay back the loan.
Debt Service Coverage Ratio
The DSCR is a figure that determines how much of a given income is available for the payment of debts. Lenders use this figure to ensure that borrowers always have enough income to pay off their loans.
Lenders also take note of the credit history of a business when considering it for a loan. Good credit history is a requirement for a commercial loan. The business must have little to no unpaid debt as well. In some cases, the business owner’s personal credit score may also come into play.
When applying for a commercial loan, lenders require that a business have proof of consistent liquid profit and not equity. The lender may even require that your business have a certain minimum net worth.
Application Process for a Commercial Mortgage
Different lenders may have varying procedures for applying for commercial loans, but most systems should follow these steps.
Analyzing your Finances
Before you can approach any lender, you must take a good review of your business finances to ensure that it is all up to standard. This includes analyzing the profitability of your business, projected growth and revenue, and other factors.
Ascertain your Financial Needs
Proper preparation for a commercial loan application involves finding out what other financial factors may come into play with your loan. This involves answering questions that pertain to the financial running of your business. Such questions include whether the property is to be leased, probable expansion plans, maintenance or renovation budgets, and recurring costs for the running of the property.
Acquire Necessary Documents
When approaching a mortgage lender, certain documents are required of you. It is important to have all of these documents in order. They include:
- A feasible and detailed business plan
- Updated financial records for the business
- Information on the management staff of the business
- Details on the commercial property to be purchased.
Discuss with Your Lender
Once all of your documentation is ready, the next step is to talk to your lender. Your goal should be to prove to them that you can handle the cost of paying back the loan. Before you bid on a property, you should get the go-ahead from your lender. This involves discussions on the type of commercial mortgage that best suits your business, any other documentation you may need, and more.
Bid on the Property
With the go-ahead from your lender, you can now make a bid on the property of your choice. This is not a decision that should be made lightly so it is important to take as much time as necessary before making an offer on a property. The offer should be made with at least two months to spare before you need to use the property. It gives the lenders time to finalize the loan.
Commercial mortgages are very common, but, because of how much they differ from traditional mortgages, the application process may cause some confusion. It is essential to fully understand all the aspects of a commercial loan before applying for one. This helps to ensure that you get the best property and mortgage deal for your business.
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