Commercial Mortgages

Commercial Loan versus Commercial Mortgage

Often, the terms 'commercial loan' and 'commercial mortgage' are used interchangeably to umbrella business financing options such as:

• Buying property where you will operate your business
• Buying property for the purpose of leasing it out
• Business startup financing
• Overdraft protection
• Lines of credit

For the purpose of this article, we will be discussing the use of commercial mortgages for the purpose of buying property.

Commercial Property

While discussing residential purchases, you are normally talking about a single-family houses, duplexes, townhouses, or condominiums. The term 'commercial property' describes a much more expansive property description, including:

• High-rise office buildings
• Apartment buildings
• Car washes
• Hospitals
• Retail shops
• Gas stations
• Movie theatres

The list could go on almost indefinitely, but I'm sure you get the idea. In other words, by definition, commercial property is used for the purpose of making money rather than as simply a means of shelter. This is important to understand because the qualification factors for a commercial mortgage are based largely on the earning potential of the property.

One of first things the mortgage lender will want to know is the cost of the building versus the net income potential. They do this by calculating a Debt-Service Coverage Ratio (DSCR).

Debt-Service Coverage Ratio

A basic DSCR equation looks like this:

Income –Expenses (net income) /Mortgage Amount (including interest)

The lender will look at this on an annual basis, to insure that the property can feasibly make more money than it costs to finance it.

For example, if a retail shop costs $1 million with an annual mortgage payment of $70,000, and the business owner can show that the potential net income is $120,000, then the formula would be: 120,000/70,000 = 1.71 DSCR This means the potential annual income from the property can cover the cost of the annual mortgage payments 1.71 times over. This would service as evidence to prove the property could pay for itself.

Qualification Doesn't Stop There

The lender will also want to examine the creditworthiness of the mortgage guarantor, which could be different from the borrower. Often, the borrower is a company that operates as a corporation or limited liability partnership, while the guarantor may be an individual who has an interest in the company.

The guarantor will go through a credit check similar to that of someone who is applying for a home mortgage. This is just another reason why a business owner will want to check his credit report periodically and ensure it is free of an inaccuracies that may have a negative impact on his credit score.

Commercial Mortgage Options

Business owners can choose from some of the same Types of Mortgages that a residential borrower would have. This means it is still important to shop around for the best interest rate and terms, and deciding if you should commit to a fixed rate loan, an adjustable rate mortgage, or some sort of hybrid that encompasses terms indicative of both types of mortgages. They may also want to look into small business financing options, which may save thousands in interest over the course of the mortgage term.

Another consideration for a commercial mortgage borrower are the terms of the note and how they affect the management of the property. For example, a lender may set forth terms that define the condition the property must be kept in, leasing restrictions, and penalties for an early payoff of the principal balance.

In Conclusion

Commercial mortgages are readily available to those who have done their homework and can provide statistical data that shows the purchase is a good business move; however, not all home mortgage lenders also make business property loans. You may need to find a specialized lender to approve the financing you need.