Commercial Mortgages and Residential Mortgages: What’s the Difference?

If you’re already a homeowner with a residential mortgage, and are also a business owner looking for a commercial mortgage, you might think the process is going to be exactly like when you got your home loan. But the two do have some differences among them. And being prepared for those differences will help you be better prepared for not only applying for that commercial mortgage, but it will also help you be approved for it!
The first thing to understand about commercial mortgages is that the terms are generally shorter than they are for residential loans. While the mortgage on your home might be set at a term of 10 or 15 years, it’s not uncommon for commercial mortgages to have terms of 3, 5, or 7 years. Often at the end of the term, there’s also a balloon payment attached to commercial mortgages, where the borrower must make a larger payment to close the mortgage out and pay it off in full.
Speaking of paying your commercial mortgage off at the end of the term, prepayment penalties also somewhat differ when it comes to commercial and residential mortgages. Home loans sometimes come with prepayment penalties, where the lender will charge you a certain amount if you pay off the loan before the term is up. However, there are few residential mortgages that come with this clause or condition. However, nearly all commercial mortgages do and if you want to pay off that commercial mortgage early, you can probably count on having some sort of fee attached. Pay your mortgage off early in the beginning of the term, and the fees are likely to be quite large; while if you prepay the rest of your mortgage near the end of the term, the fees are generally going to be quite lower.
Another, bigger difference to many, is the fact that commercial mortgages generally aren’t as large as residential mortgages. With a home loan, you’ll most likely be able to apply for 100% of the total home’s price if you need to (although you may have to also buy mortgage insurance if the amount is over 80%.) However, commercial mortgages are a riskier business to lenders and so, the total amount of the mortgage will probably not be as large; and you won’t be able to buy mortgage insurance to cover the difference. The exact amount you receive for your commercial loan will depend on the lender as many consider the type of commercial building that they’re providing the loan for. So while a lender may only provide 60% of the mortgage on a restaurant, the same lender may also provide 75% of the mortgage on a warehouse building.
The one thing you can expect to remain the same about a commercial mortgage is the debt to income ratio. Of course, here the lender will not examine your own personal income and debt but rather, the business’. The lender will want to see how much profit the business has generated so far, and what the future profits are going to look like. Lenders also look at a business’ DCR (debt coverage) to get an idea of how much debt the business carries. In order to obtain a commercial mortgage, lenders typically require businesses to have a DCR of 1:1.25. This means that the business’ income will be 1.25% more than the debt it carries.
Commercial mortgages and residential mortgages will both help you attain your dreams and your goals. But, in order to do that, you first need to understand the differences between the two. Then when you’re ready to march into your lender’s office with paperwork in hand, you’ll be that much more confident that your business is going to have a new home very soon!