Commercial Vs. Residential Loans

Written by kristie lorette
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The uses of residential properties and commercial properties are different and so are the mortgage loans used to finance the purchase of these two types of properties. While there are some similarities between residential and commercial mortgage loans, there are also quite a few differences.

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Income

When an individual or couple applies for a residential mortgage, one of the financial aspects the lender asks about and confirms with documentation is the personal gross income and the amount of debts the applicant carries. Most lenders do not want your debt to be less than 45 per cent of your gross income and they don't like to see your mortgage payment using more than 28 per cent of your gross income.

When it comes to financing the mortgage for a business or commercial property, the lender typically looks at the financial situation of the business and its ability to generate income, and the lender also looks at what the business debts are. In a commercial mortgage situation, the ratio used to determine how much of the business debts use the income of the business is called the debt coverage r(DCR). Commercial mortgage lenders like to see that the business has a 1:1.25 DCR, which means that its income is 1.25 per cent greater than its debts.

Loan-to-Value Ratio

The amount of money that a lender will mortgage a property for and the amount the borrower is required to put down as a down payment is another difference between residential and commercial properties. Residential lenders may allow for financing of up to 100 per cent of the purchase price, while others will only loan up to 80 per cent. When a residential loan amount is more than 80 per cent, private mortgage insurance (PMI) is required by the lender. PMI is insurance that protects the lender against default for loaning you more than they normally would. The payment for PMI is added to your monthly mortgage payment.

Since commercial real estate is considered to be riskier than residential real estate, commercial mortgage lenders loan less on the value of a commercial property. The amount a lender will loan can also vary by the type of commercial property it is. For example, a lender may loan up to 75 per cent on an apartment building, but loan up to 80 per cent on a business warehouse.

Loan Term

The other main difference between residential and commercial loans is the term or length of the loan. A residential mortgage can go up to a 30-year term. Other common residential mortgages are 15-year terms. There have been lenders that are known to have gone as long as 40 years on a residential mortgage, but this is very rare.

Commercial loans, on the other hand, have much shorter terms than residential mortgages. The typical term of a commercial mortgage goes up to 10 years. There are some lenders that will go 15 or 20 years, but this is not as common as terms such as three-, five-, seven- and 10-year terms.

Penalties

While some residential mortgage lenders have prepayment penalties, where fees are assessed to the borrower if they pay the loan off early, it is not a common practice in residential lending. This means that if a borrower pays off their mortgage early, he sells the property or refinances into a new mortgage--no fees are assessed by the existing lender.

In contrast, it is a very common practice for commercial lenders to impose prepayment penalties on commercial mortgages. These penalties are typically steeper at the beginning of the loan, and decrease as the term of the mortgage nears.

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