Commercial mortgages explained
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Table of Contents
What is a commercial mortgage?
A commercial mortgage is a form of mortgage offered to business owners who want to purchase commercial real estate, such as an office, retail space or factory. They work in a similar way to residential mortgages in that you borrow money that is secured against the property itself, offering an ideal solution if you are looking to expand your business or investment property portfolio.
How much of a down payment will I need?
The down payment required for a commercial mortgage depends on many variables, but usually falls between 20% and 50% of the cost of the property. The portion of the purchase price that you borrow is referred to as the loan-to-value (LTV) ratio. For example, if you are providing 30% of the purchase price and borrowing the rest, you will have a LTV of 70%.
Here are some of the factors that will influence your maximum LTV as well as other aspects of your mortgage, such as the loan term and interest rate:
- Cash flow. One of the main things lenders will consider is the ratio of the cash flow your business has coming in versus the amount that will be required to cover the mortgage payments.
- Credit rating. Most lenders will look at both your personal credit rating as well as the creditworthiness of your business.
- Business. The type of business you run, the length of time you’ve been in business and the growth rate of the business will all influence a lender’s decision.
- Property. The type of property you wisn to finance can have a significant impact on the down payment required. For example, a storefront with upstairs apartments in a busy part of the city may require a much lower down payment than farmland in a rural area.
The down payment and other terms and conditions of your commercial mortgage are often negotiable, and there are many variables to take into account. For example, you may even be able to qualify for a commercial mortgage with a 100% loan-to-value (LTV) ratio, meaning zero down payment, if you are able to provide sufficient additional security, such as assets or other properties.
Commercial mortgage interest rates
Commercial mortgage interest rates are generally higher than residential rates. They can vary from just a couple of percentage points higher to much higher than that – it really comes down to the amount of risk the lenders sees in your specific business and property.
If you take out a commercial mortgage at a high interest rate today, it may be possible to find better refinancing rates down the road as market conditions change or your creditworthiness improves.
There may also be flexibility in how you structure your commercial mortgage, as you may generally choose terms of 5, 15, 20 and 30 years, and amortize your payments over periods just as long or even longer. Ideally, you will find a combination of interest rate, loan term and amortization period that makes your monthly payments manageable.
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Residential vs. commercial mortgages – what’s the difference?
If you already have a residential mortgage, you might assume that acquiring a commercial mortgage will follow the same process. Although there are many similarities, there may also be a number of differences, including:
- • The income of your business is going to be more important than your personal income. Lenders will generally want to see that your commercial enterprise will be able to cover the loan payments. Having said that, they will still likely review the big picture, including any personal income or liquid assets that could potentially provide additional security if they were to offer you a loan.
- • There might be more due diligence about the property itself. Whereas many residential properties, particularly in dense urban settings, have many comparable properties that help the lender understand property values, commercial properties can be more dynamic. The lender may need to conduct more research into the property’s age, condition, location, purpose and suitability for your business.
- • The terms and conditions of a commercial mortgage will be different from residential mortgages. For example, generally speaking, a commercial mortgage will come with a higher down payment, a higher interest rate and a shorter term. You may also find that there are higher application fees and higher prepayment penalties. Finally, it is likely that the application for a commercial mortgage will take more time to complete.
You might be wondering how a mixed-use property would be treated – such as a retail storefront with apartments upstairs where you could potentially live. In general, you should expect the mortgage process to be like that of any other commercial property because lenders consider the overall complexity and risk profile to be similar.
Commercial second mortgages
A commercial second mortgage can be a good way to access the equity within a commercial property.
For example, imagine a business has owned a commercial building for several years and has paid off a considerable portion of their first commercial mortgage. Imagine also that the building has appreciated in value since it was originally purchased. There is now a considerable amount of equity in the property.
Now say the business needs an injection of cash in order to finance its growth. One option would be to apply for a commercial second mortgage where a lender agrees to loan the business some portion of the available equity in the building. In exchange, the second mortgage holder will have a claim against the property if the business fails to make the mortgage payments. Note, however, that this lender will be second in line behind the first mortgage holder in the event of a default.
How do I get a commercial mortgage?
Applying for a commercial mortgage is a little more work than applying for a residential mortgage.
The first requirement is to have a profitable business. Lenders will want to see that your business has enough excess monthly cash flow to cover the mortgage payment. If you can show a proven track record of paying a comparable amount of rent, you may be well on your way to qualifying for a commercial mortgage and becoming a new property owner.
Another requirement is to have a good property in mind. Lenders will review the property itself – including its age, condition and resale potential – as well as its suitability for your business. Keep in mind that commercial properties can come with lots of extra bills such as higher property tax, utility and maintenance costs, plus the cost of the move itself.
Before you actually bid on a property, it’s wise to have your financial statements, business plan and details of the property ready to share with the lender. They might set out specific conditions for the financing, such as obtaining environmental and building condition assessments, an appraisal and a title search. Although you might be ready to close on a new building in 30 days, be prepared for the financing process to take longer than that.
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Can I get a residential mortgage on a commercial property?
Not exactly. If you already own a residential property, you could potentially take out a home equity line of credit or residential mortgage and use the proceeds to purchase a commercial property. But if you are purchasing a commercial property and pledging it as security to a lender, you will generally need to go through a commercial mortgage lending process.
How long is a typical commercial mortgage?
Term lengths can vary and generally include 5, 15, 20, 25 and 30 year commercial mortgages.