What Is the Difference of a Commercial and Residential Real Estate Loan?
If you’re a real estate investor, then odds are you have dealt with a multitude of different properties. If you are more used to dealing with residential properties, then commercial real estate may be foreign to you. If you are a house flipper, then after a certain amount of units, usually about 5, you have to enter into a commercial loan. Whether you’re a house flipper or purchasing a commercial property, you may wonder how different it will be from a residential mortgage.
Term and Repayment
In commercial mortgages your loan doesn’t end when you finish paying down the principal balance. The commercial loan term is shorter than the repayment schedule. For instance, you may be paying at a rate that would take a traditional 25 years to pay off. However, this doesn’t mean that you have 25 years to pay it off. You may be on a schedule that ends in five years. This means that you will have to pay back the full balance at the end of those years. Normally, investors do this by refinancing or selling the property.
Pre-Approvals and Term Sheets
In residential mortgages, you are pre-approved for a loan amount before you even try to purchase a home. When you are looking into commercial mortgages, you put the property under contract. Then, when you do that, you look for financing. You get a term sheet. A term sheet depends on the financials of the purchased property. You need to use some caution when it comes to the amount of financing that you need.
When it comes to commercial real estate mortgages, you may have to deal with prepayment penalties. This requires the borrower to pay additional percentages on top of the loan amount so that they can pay the loan off early.
In a residential mortgage, you may lose all of your equity and the bank may take your house in the worst-case scenario. With commercial loans, however, you have to deal with recourse. This means that you may be liable for the full loan amount. In most cases, this is going to be even larger than your equity.
If you’re getting into commercial real estate for the first time, it might look intimidating at first. It’s difficult entering into a new market. However, residential real estate is a great introduction into real estate financing, in general. Knowing the differences will make the process go smoothly.