What is a Commercial Mortgage?

A commercial mortgage is a type of loan that is secured by real estate and used for the purchase of a commercial property with the goal of producing income. 

A commercial mortgage will differ from a residential mortgage in some key traits. Residential mortgages are more common, but commercial ones are very important for businesses.

A residential mortgage is a lien that uses the property as collateral, and the same is true for a commercial mortgage that will use the office building, the factory, the warehouse, the apartment building, or whatever other types of commercial property the business requires.

Commercial mortgages can be a lot more complex, and take longer to finalize. They have their own sets of challenges, but they can also empower businesses that otherwise wouldn’t be able to afford to get off the ground.

How does a commercial mortgage work?

These types of mortgages usually take longer to finalize than a mortgage for a private investment property. It can take months, or even a year for a commercial mortgage to be prepared. When dealing with business mortgage loans, the financing terms for the company can be costlier than residential mortgages, but commercial real estate is essential for running a business and commercial mortgages are necessary for most businesses to afford a commercial property. The following sections will take a closer look at some of the finer details of commercial real estate loans.

Financial Ratios for Commercial Buildings

There are a number of ratios that can be factored in when a financial institution is assessing the viability of commercial mortgage lending to a business. Here are 2 of those financial ratios:

  • LTV (Loan-to-value): This is the amount of money that is being borrowed versus the total value of the property that the loan is being used for.
  • DSCR (Debt-service-coverage-ratio): This is the income of the business compared to the amount of money they’ll need to pay towards their commercial real estate mortgage.

Who can take out a commercial mortgage loan?

A commercial real estate loan is given to a corporation, a trust, a limited partnership, or some other structure of a business entity. This differs from a residential mortgage, which is given to an individual investor. If the business entity doesn’t have a suitable credit rating, then the individual owners of the business may be required to co-sign (guarantee) the loan, to offer protection to the lender in the event that the business fails and isn’t able to continue making their payments.

In some cases, certain corporate structures can protect the owner from personal financial liability in the event of the business defaulting, but these arrangements may come with higher costs, since the lender of the mortgage has less recourse should the business fail.

What is the difference between residential and commercial mortgage?

Certain types of residential properties can also be financed using a commercial mortgage. These include various types of income properties such as  buildings with 1 or multiple units, or a residential/commercial mixed property (such as an apartment building that has a store and a restaurant on the main floor.) 

Commercial Mortgage Fees and Interest Rates

Expect to pay a higher interest rate on a commercial real estate loan, along with additional fees. This is just a cost of doing business and should be accounted for in your business plan. Many businesses don’t last long enough to outright own their own property, so they will lease instead. There are pros and cons to either model that need to be calculated based on the unique circumstances of your business, your long-term plans and goals, and your current situation.

The three categories of costs are the ones that are required to get the mortgage started, the costs of servicing the debt, and any additional costs that are necessary to exit the loan.

Here are some of the additional fees you can expect to encounter, beyond the payments on the mortgage itself.

  • Application fees: There are standard fees that are required in order to apply for a commercial mortgage.
  • Appraisals and valuations: A professional appraiser will determine a fair market value for the property, and there is a cost associated with this.
  • Property condition assessment: An engineer will assess the condition of the property and ensure that it’s structurally sound. This prevents a mortgage from being signed for a property that ultimately ends up needing an additional huge investment to make it usable, as that would be an unexpected cost that the borrower wouldn’t be able to afford.
  • Legal costs: The legal fees for a commercial mortgage can add up to a substantial amount, potentially around 1% of the total purchase price of the property. This can include title searches and other research fees, among other duties that a lawyer will perform.

Repaying a Commercial Mortgage vs. Residential 

One of the key differences between these types of mortgages is how the repayment schedule works. With a conventional investment property mortgage, the total length of the loan is usually 30 years (which is divided up into smaller chunks at which point you can refinance.) 

A commercial loan, on the other hand, usually needs to be paid back in a shorter amount of time, yet will have a longer amortization period.

You could have a commercial loan with a term of 5 years and an amortization period of 25 years. This means that you’ll make monthly payments over a period of 5 years as if the loan was actually for 25 years. At the end of the five years, you’ll owe a balloon payment of a lump sum of the remaining amount. 

What deposit is required for a commercial mortgage?

If you’re wondering how large of a deposit/down payment you’ll need to make on a commercial mortgage, the answer is that it’s negotiable and it can vary. Down payments on commercial mortgages are much higher than on residential mortgages. If a business borrows money and goes out of business, it can be costlier to convert that property for a new business to take over, it can take longer to find someone to purchase the space, and it can be a lot trickier for the lender to get their money back.

How many years is a commercial mortgage?

The length of payment for commercial mortgages can be 5 years on the lower-end, or upwards of 20 years on the high-end. 7-10 year payment lengths are quite common, and again, at the end of the loan, a balloon payment will be due. Otherwise, the monthly payments while the business is becoming established would likely be prohibitively high for most new businesses.

Where To Get a Commercial Mortgage

In America, according to data gathered in 2013, only about 49% of commercial mortgages are held by banks. 18% of them, at that time, were held by asset-backed trusts, 12% held by government-sponsored enterprises, and finally, 10% of commercial and multi-family income property mortgages were held by life insurance companies.

This gives you an idea of where you can look for a commercial mortgage on your own, but it might be easier to deal with a broker. Banks are a good place to start. They will want to see your financial information (for the business that you represent, and likely for yourself as well depending on the history of the business.)