What Is A Commercial Loan?
If you’ve never borrowed money for your business, you may be in for a surprise. Whether you want to borrow working capital to expand your business or leverage equity in a commercial real estate venture, you will soon find the commercial loan process is very different from the more-common home mortgage process. Commercial loans, unlike the vast majority of residential mortgages, are ultimately backed by a governmental entity such as Fannie Mae. Consequently, most commercial lenders are risk-averse; they charge higher interest rates.
What Do I Need to Qualify?
Most frequent questions and answers
One of the main differences between a residential and commercial loan is the amount of weight the credit score holds. It’s always better to have a good credit score. For residential mortgages, a lot hinges on your credit scores only, and of course income. But with commercial real estate loans, credit score is not the top consideration.
When applying for a commercial loan, one of the first things a lender will look at is the business’s net worth. Your net worth is the difference between your assets and your liabilities.
Liquidity is also a significant factor. For a $1,250,000 loan, if covering the $250,000 down payment exhausts all your liquid cash, the lenders will look upon that as a little weary because you have no cash left. They don’t like to see someone use all their cash after a closing and then not have anything for an emergency, such as a $10,000 to $20,000 deductible for an insurance claim.
The liquidity requirement varies from lender to lender. The general rule is 10% to 20% of the loan amount. If you want to borrow a million dollars, you have to have at least $100,000 after closing; $150,000 or $200,000 is even better. Other times lenders may require 6 to 12 months’ worth of principal and interest payment. If the monthly payment is $10,000, for example, a lender may want to see $120,000 in liquidity.
Ownership & Management
The lender will also want to know about your ownership experience. Owning a duplex or three or four single-family rentals, or maybe 10 or 12 (you could even have 30 of them) – that’s even better if you have a large portfolio of single-family rentals. But if you’ve only had one or two, and maybe a couple of duplexes, that’s not the same as a multifamily because it’s a little bit different animal.
If you are purchasing anywhere between 5 and up to maybe 50 units, the lender will pretty much allow you to self-manage the property because there’s not a lot of third-party management of that size; it’s just too small, and they don’t make enough money on it. Therefore, since you will be self-managing, the lender will want you to have previous management experience. Do you know about leasing? Do you know how to perform credit checks, verify employment, and run a background check?
If you aren’t managing the property yourself, however, ownership experience will be more important than management experience.
Finally, the last area a lender will be asking about is your income, whether you’re self-employed or a W2 employee. If you already own a portfolio of properties, they will want to look at your global cash flow, which is how much cash you earn after debt service. If you experience a hardship on one property, the lender wants to make sure you can move cash around to keep all your debt service intact.
There’s no ratio on [global cash flow]. We typically don’t use your debt-to-income ratio, in commercial real estate. We look at the property’s loan-to-value, and debt coverage ratio, meaning how much does the net operating income exceed the monthly principle and interest payment.