Commercial vs. Residential Loan Terms: 4 Key Differences

There are many differences between a commercial and residential real estate loans.

Who’s Income Matters?

When you apply for a residential mortgage, among the first things a lender looks at is your personal gross income and the amount of debt you owe. As a rule of thumb, lenders want your debt to be no more than 45 percent of your gross income. Your mortgage payment alone should be no more than 28 percent.

When evaluating a business that has applied for a commercial real estate loan, it is the ability of the property being considered to generate income compared to the debt on it. This is called the Debt Coverage Ratio, or DCR. A DCR of 1:1 means a property earns what it owes. Lenders like to see a DCR of 1:1.25.

Down Payments

The down payment on a residential loan is negotiable. In a strong housing market, it is relatively easy to get a zero-down mortgage if you have good credit. If your Loan-to-Value Ratio is more than 80 percent, that is if the loan you want is more than 80 percent of the home’s current market value, you will have to pay Private Mortgage Insurance, or PMI.

As stated above, a commercial real estate loan is considered riskier than a home mortgage. As a result, lenders generally require a 20 percent down payment and an 80 percent Loan-to-Value Ratio. In a strong business climate where lenders are competing for loan business, 10 percent down on commercial property is possible.

Length of Payment

A conventional residential home loan has a 30-year term. Residential home loans can be negotiated to 15-year or even 40-year terms. When a housing market is very strong and lenders believe values will climb, even 50-year mortgages are offered. But the standard is 30 years.

For a commercial loan, again because the risk is considered higher, a 10-year payout is typical. As with residential mortgages, anything is negotiable, but business properties often are sold to long-term investors before the 10-year period is up.

Penalties

A typical residential loan can be paid off at any time, regardless of the payout term length, without penalty. Many residential loans are refinanced if interest rates drop, and this would be made less cost-effective if there were prepayment penalties.

However, commercial real estate loans typically do have prepayment penalties. It all goes back to the risk of the loan in the estimation of the lender. Typically, the commercial loan prepayment penalty is on a sliding scale, growing smaller as a percent of the loan each year.