Differences Between Commercial and Residential Loans
Commercial and residential loans have some similarities. Both types of loan are taken out on properties and they both use the property itself as collateral. However, despite sharing these similarities, both commercial and residential also have key differences that encompass a completely different set or rules for each loan.
What exactly sets commercial and residential loans apart from one another? More importantly, what do business owners need to know before making a mortgage agreement? Here are a few of the key differences between commercial and residential loans.
Borrowers and Lenders
Unlike residential mortgages that are typically between banks and the individual buyers, a commercial mortgage is made to a company. For tax purposes it is usually in the best interest of borrowers to sign as representative of a business entity. This is because the property is zoned for businesses uses.
Commercial loans are also usually at higher risk than residential loans. If an owner of a residence and commercial property has financial difficulties, they will need to make sure their home mortgage is paid first, and more often will become delinquent on their commercial property mortgage.
Commercial mortgages also usually have higher interest rates and shorter terms than residential mortgages. This is because there is a smaller secondary market for commercial loans.
Commercial Loans Require Business Plans
A business plan is just as important as a credit score if you’re hoping to obtain a commercial loan. Commercial loans are most concerned with the actual property and cash flow than residential loans. If you are shopping for a commercial loan, be prepared to answer a lot of background questions regarding the property. Some of these questions include:
- Who pays the utilities?
- What types of maintenance are required?
Numerous questions regarding cash flow will also be asked. Commercial mortgage borrowers should be prepared to provide proof of business revenue and profits as well as a detailed plan for how the commercial property will generate enough income.
The Loan Terms, Restrictions and Penalties
Homeowners usually finance their properties over lengthy periods of time. The most common are usually 30-year mortgages. Although residential buyers have many options available, this is ideal due to longer amortization periods that create smaller monthly payments. Furthermore, residential loans are typically amortized over the life of the loan so the loan is fully repaid at the end of the term.
However, unlike residential loans, terms for commercial loans typically range from 5 years to 20 years, and the amortization period is often longer than the loan term. Commercial lenders are also able to customize the loan repayment schedule to each borrower’s specific requirements.
A commercial real estate loan may have restrictions on prepayment, which is designed to preserve the lender’s anticipated yield on a loan. If the borrower settles a debt before the loan’s maturity date, they may be required to pay prepayment penalties. Prepayment terms are usually highlighted and identified in the loan documents and can be negotiated along with other loan terms in commercial real estate loans. In contrast, residential loans do not typically have prepayment penalties and can be paid off at anytime during the term.