Banks & Private Loan Alternatives for Commercial Mortgage Loans: Part 1

The commercial loan process is very different from the residential mortgage process. Commercial loans, unlike the vast majority of residential mortgages, do not receive backing from a government entity like Fannie Mae. As a result, commercial lenders are more risk-averse than their residential counterparts and in turn, they charge higher interest rates than those associated with home mortgage loans.

Some lenders even go a step further and scrutinize the borrower's business itself, as well as the commercial property that will serve as collateral for the loan. For these reasons, the business borrower should prepare for a different experience when applying for a commercial loan versus that of a loan secured by his or her primary residence.

If you are considering applying for a commercial mortgage loan, refer to the following list of questions before you speak with a commercial lender.

1.  How will I meet the repayment terms on this loan? 

It is typical for banks to require the borrower to repay his or her entire business loan much earlier than its stated due date.  Banks do this by requiring that their loans include a balloon repayment. This means the borrower will pay interest and principal on his 30-year commercial mortgage at the stated interest rate for the first few years (generally 3, 5 or 10 years) and then repay the entire balance in one balloon payment after that initial period. 

This can be challenging as many borrowers are unable to save sufficiently in this short time period, so they must either re-qualify for their loan or refinance the loan at the end of the balloon term.  If the business has cash-flow problems in the years immediately preceding the balloon term, the lender may require a higher interest rate, or the borrower may not qualify for a loan at all. If this happens, the borrower runs the risk of being turned down for financing altogether and the property may be in jeopardy of foreclosure. 

These loans have other risks, too.  The lender may turn-down refinancing options if the borrower's business is perceived to be in a high-risk industry. Alternately, a commercial lender may determine it has too many loans in a given industry, so it may deny subsequent refinancing in that vertical.

Let's talk about alternate lenders because they may offer less stringent requirements for commercial loans. Some non-bank lenders will make long-term commercial loans without requiring the early balloon repayment.  While these loans may have a slightly higher interest rate, they generally work more like a typical home loan. They allow a steady repayment over a thirty-year period, for example.  Evaluate whether paying one or two points more on the interest rate offsets the security of a long-term, fixed rate mortgage loan. 

2.  How much should I borrow?

Because most banks will prohibit additional mortgages on a commercial loan, you should plan to borrow enough to meet the current needs of your business, or enough to be able to leverage your real estate investments.  For a traditional, commercial acquisition loan where the borrower seeks to purchase a new property, banks will require a down payment of 20-25%. For a ,000 acquisition for example, the borrower needs to come up with ,000-,000 just for the down payment. 

However, there are alternative lenders who will allow you to make smaller down payments and maximize the loan-to-value (LTV) at 85-90%.  Direct commercial lenders or pools of commercial investors are frequently the only sources of these loans. If you do need to borrow the maximum amount, you should understand that the interest rate will likely be a point or two higher than that of traditional bank loans.  You, the commercial borrower, must evaluate how much capital you need and carefully analyze your ability to repay your commercial loan.

Consider that statistically, it's been shown that the most significant reason for most small business failures is lacking adequate capital to meet cash-flow needs.  Because of this, it may in fact be safer for a small business borrower to leave a larger cushion against unforeseen events by borrowing more money at a slightly higher rate.   

It's also important to note that the amount of the proposed mortgage loan will impact the commercial lenders who might potentially fund the loan. Small business loans are generally made by direct commercial lenders (easily located by internet searches) or by small local banks.  Larger loans are generally made by regional banks, while extremely large loans are made by mega-banks or Wall Street lenders. This is to say that small businesses borrowing less than ,000,000 will be placed in a different pool of potential lenders than those seeking loans of over million. 

Please continue to part 2.