A major difference between the two types of mortgages is who actually takes out the loan. Residential mortgages are almost always made to individuals. Commercial mortgages on the other hand are usually lent to entities like corporations, trusts or similar groups. The groups themselves may or may not have an established financial history. A commercial lender will therefore look closely at the finances of the groups individual owners and may require them to individually pledge their personal property as collateral before any loan is approved. This is known as recourse, or secured loan. With residential mortgages the value of the home is usually enough in terms of collateral and the bank only considers the credit history of individual borrowers.
A traditional residential mortgage is often amortized. This entails the borrower making fixed payments over the course of the loan which goes toward both the loan interest and the principle. This means most residential mortgages are paid in full once the loan matures. Commercial mortgages usually entail balloon payments were a borrower makes monthly payments for a period of time. However once the loan expires the borrower must repay the remaining loan balance in full. Commercial mortgages also usually come with pre-payment penalties built in. A simple prepayment penalty entails the borrower repaying the outstanding loan balance multiplied by a given number. There are also interest guarantees, where the lender is entitled to a certain amount of interest even if the principle is paid off in full. Some commercial mortgages may simply have lock out periods, in which the borrower can’t make any extra payments towards the loans principle for a given period. Since the recession, very few residential mortgages are structured around balloon payments and very few come with pre-payment penalties.
A debt service coverage ratio (DSCR) is the amount of income a property generates when compared to the owners debt obligations. Such a calculation does not apply to residential mortgages, as residential properties don’t generate income (however a residential borrower’s income may be compared with their outstanding debts). For example if a property generates 140,000 in income annually and the outstanding mortgage is for 100,000 dollars then the DSCR is 1.4. A DSCR helps lenders evaluate how much debt a commercial borrower can carry. A DSCR less than 1 indicates that the property doesn’t generate enough revenue to meet outstanding mortgage obligations. Lenders usually require commercial properties to have a DSCR of at least 1.25 before any mortgage can be approved.
Something all lenders consider is the value of a loan compared the value of the property being financed; this figure is known as an LTV. This indicates how much equity an owner has at stake in the property being financed and in the case of residential and commercial mortgages the lower and LTV the better. Due to government programs some residential borrowers can qualify for mortgages approaching 100 percent of their properties market value. Commercial borrowers very rarely get loans exceeding 80 percent of a properties market value. This means commercial mortgages usually come with significant down payments.
In summary, the terms of a commercial mortgage are different because borrowers are usually groups of investors. Commercial mortgages often come with balloon payments and pre-payment penalties which are uncommon among residential mortgages. Commercial properties are also valued differently and this greatly impacts the terms of a commercial mortgages and how much money a borrower can receive.
Level 4 Funding LLC Private Hard Money Lender
Arizona Tel: (623) 582-4444
Texas Tel: (512) 516-1177
Dennis@level4funding.com NMLS 1057378 | AZMB 0923961 | MLO 1057378
22601 N 19th Ave Suite 112 | Phoenix | AZ | 85027
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About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 42 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.