#AskTheDanielMtz Ep. 52: From Residential to Commercial Real Estate

When you’re thinking about starting a business, the first thing to do is arm yourself with as much information as possible. Take your time, do your research and explore all the possibilities. There are a lot of steps to go through before you can open your doors and welcome your first patron. An important step is to acquire a commercial space to operate from, which usually means you’ll need to take out a commercial loan.

@SirJoshAaron Asks: How commercial loans differ from residential loans?

There are four factors that set commercial and residential loans apart:
 — Whose income matters?
 — What’s the downpayment?
 — What is the length of payment?
 — Who pays penalty fees?

With income, residential loans focus on the individual who is applying. Lenders scrutinize their income statements, their debt to income ratio and credit score. Debt to income is weighed heavily. Is the applicant within the 45% threshold of debt to income? How much of their income will have to go towards paying their home loan? Ideally, they’re looking for a number between 20 to 28 percent. Commercial loans, however, focus on the actual space. Does the space and business have the potential to generate enough cash to offset how much debt they’re accruing on the loan? Based on the projected profit, lenders make their decision.

Down payments on residential loans vary from application to application, but they can end up being a grand total of ZERO. Commercial loans, on the other hand, usually require down payments that are anywhere between 10 to 20%. Since these loans are generally more risky, lenders want to see more skin in the game.

Length of payment terms for FHA, conventional and VA loans (which are all types of residential loans) are typically available in 5, 10, 20 or 30 years — 40 years if you’re really lucky. Commercial loan terms average around 10 years. More than anything, they want to ensure the space is generating enough business year after year. These terms are all based upon what you bring to the table when structuring your loan, who then lender is, and the type of deal you’re making.

Lastly: payment penalties. First, it’s important to understand what these are. These penalties are essentially the opposite of late payments: early payment. Chances are, you’ll probably never hear a peep about payment penalties when setting up a residential loan. In commercial loans, however, lenders want you to go the full term of your loan, even if you’re making enough money to pay off your loan sooner. If you have a ten-year loan term in place but you’re projecting you may be able to pay it off in eight years, resist. As you go along, your fees will get lower and lower.

All of these distinctions are important to know. Loans are a tricky business on their own, but knowing what you’re getting into ahead of time will save you a world of trouble.

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