Commercial vs. Residential Mortgages
Both commercial and residential mortgages are loans taken from a bank for the purpose of acquiring real estate. Every mortgage has three parts: the principal is the initial cost of the property, interest is added on each payment and is calculated based on the length of the loan, and amortization is the length of time that is agreed on to pay off the principal. The longer the amortization period the smaller the monthly payments will be, but the more interest will be accumulated. So while taking longer to pay off debt means a reduced payment each month, it also means more in interest paid over time.
Each of these mortgages has different criteria that need to be met in order to be approved for a loan. The main variables considered for a residential loan is personal income and debt. Generally, lenders want the total debt to be no more than 44% of gross income, while the
mortgage payment alone should be no more than 39%.
For commercial mortgages, the main factor is the business’ ability to generate a profit or Debt Coverage Ratio (DCR). If a business has a DCR of 1:1 that means it is able to earn what it owes. Lenders like to see a DCR of 1:1.25. A business plan is just as important as a credit score in obtaining a commercial loan. Lenders are far more concerned with the property itself regarding this type of loan so be prepared to answer specifics like the kind of maintenance that needs to be completed. It is also important to have financial records of revenue the business generates as well as a detailed plan for how the business will make a profit at the property.
The deposit required to sign a contract for a property loan varies depending on the type of property and the state of the market. Down payments on residential properties are more easily negotiable than on commercial entities. Because commercial real estate is considered perilous, at least a 20% down payment is required.
The standard length of a residential mortgage is 25 years, but can vary between 15-35 years depending on the strength of the housing market and how quickly the borrower wants to pay back the loan.
Again, because of the risks associated with commercial properties, terms for this type of contract are much stricter with a 15-year amortization being the standard. Interests rates also tend to be higher for commercial mortgages.
Typical residential loans can be paid off at any time regardless of contract length (they can be paid off without penalty if the mortgage is open. Penalty is still required if the mortgage is closed). Commercial loans usually have penalties for early payments as the lender is expecting to earn the full amount stated in the initial contract.
As with any contract, terms are negotiable depending on a wide range of factors like credit score, income, and profit. Securing the best deal is dependent on how financially reliable the borrower is and how well the markets are doing. It is important to note that these terms are more flexible with residential loans than commercial loans and careful financial planning done be done accordingly.