How Long Can You Finance Commercial Real Estate?

September 28, 2018

Updated March 17th, 2020

If you’re looking to purchase new or existing Denver commercial properties, you can finance the acquisition and any construction or development with a commercial real estate loan. This type of loan is specifically meant for certain business entities, and liens on the property secure the mortgage. But financing commercial real estate is sophisticated and stressful and differs from financing a home. Before you get too far in over your head, it is important to understand the ins and outs of commercial real estate loans.

How Do Commercial Real Estate Loans Work?

Unlike residential mortgages that are available to individual home buyers, commercial real estate loans are available to business entities such as developers, funds, corporations, and limited partnerships. These are entities designed specifically for commercial real estate ownership. An entity may not have any credit rating or financial track record, and as such, the lender may require the owners or principals to guarantee the loan. Technically, the commercial real estate loan is secured by a lien on the property you’re purchasing. A lien is a legal right that a property owner gives to a lender as a guarantee that they are going to repay the loan. From this, the lender knows from whom they can recover the amount in the event of loan default.

Conversely, when the lender does not require any guarantee, it means that the mortgage loan is secured by the property, which can be seized if the owner can’t fully repay the debt. When you take out a commercial real estate loan, you should be prepared to make a down payment on your loan. Commercial real estate loans have no private mortgage insurance, and most lenders will typically require you to put down at least 20 percent of the property purchase price before they can fund your loan.

Interest Rates, Fees, and Loan-to-Value Ratios

Interest rates on commercial loans are based on the investor’s creditworthiness, type of business being funded, and its financial health. But commercial real estate loans come at a higher interest rate than a residential loan would. In addition, some fees apply to commercial real estate loans and add to the total cost, including loan application, legal, appraisal, loan origination, and survey fees

The loan-to-value ratio (LTV) is another factor that draws a line between residential and commercial loans. LTV measures the value of a loan against that of the property. This involves dividing the amount of loan by the property’s purchase price or appraised value (whichever is lesser). Commercial loans fall into the 65 percent to 80 percent range. A buyer is likely to receive a lower interest rate if the LTV is lower. This comes in if more of the purchase price is catered for in the form of a down payment, meaning that the lender takes on less risk.

Commercial Property Loan Repayment Schedules

When it comes to residential mortgages, the loan is repaid in fixed installments for a specified period. The 30-year fixed-rate mortgage is the most popular option for residential buyers, but one can also get a 15-year or 25-year mortgage. Longer repayment periods usually involve higher total interest costs and smaller monthly payments over the life while shorter amortization periods are characterized by lower total interest costs and larger monthly payments. A residential loan is fully repaid at the end of the loan term.

With commercial loans, there are two types of terms: an intermediate term of three years and a long-term that typically ranges from five years (or less) to 20 years. A commercial property loan also comes as a balloon loan or an amortized loan. An amortized loan involves making repayments in fixed installments until the investor has fully paid off the debt, plus interest. Conversely, a balloon payment requires the investor to make one big payment after a set number of years in order to pay off the remaining principal. The repayment period is usually longer than the term of the loan.

For instance, a lender might make a commercial real estate loan of eight years with an amortization period of 25 years. The property buyer would be required to make payments of a set amount for eight years, which is then followed by a balloon payment of the remaining balance. A buyer with a $1.5 million commercial loan at a six percent interest rate would make monthly payments of $8,993.26 for the next eight years. At the end of the eight years, the balloon payment will be $1,325,578.56 that would pay off the loan in full. The length of the amortization period and loan term will impact the interest rate. These terms may be open for negotiations, but that will be based on the credit strength of the owners or principals.

Getting the best rate and terms for your business is crucial in ensuring you bring your business to the next level. At Unique Properties, we want to help make your Denver commercial real estate buying experience as uncomplicated as possible. Contact us to learn more about how we can help you with financing.

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