Commercial financing is typically used for larger real estate transactions, including properties with five or more units, mixed-use properties, or commercial buildings.
These loans are structured differently from residential loans and often focus more on the property’s income-generating potential.
Unlike more traditional residential financing, they have much more varied qualifications and terms making it more challenging to share with you the exact details of how they’re structured.
Let’s break it down.
Eligibility/Requirements
Commercial loans have stricter eligibility requirements, often focusing on both the borrower and the property:
- Credit Score – Most commercial lenders will require a minimum credit score of 660 or higher. Strong financials are crucial, as the lender will look closely at both your personal and business finances.
- Debt Service Coverage Ratio (DSCR) – A key factor in commercial lending is the DSCR, which typically needs to be 1.25 or higher. This ensures the property generates enough income to cover its debt payments. If the property does not have enough income, you may be required to put more down—sometimes a lot more down—to get the DSCR over the required threshold.
- Financial Documentation – Lenders will require detailed financial statements, including tax returns, a profit and loss statement, rent rolls (if applicable), and proof of assets.
Owner-Occupancy Requirement
Commercial loans rarely have owner-occupancy requirements, making them ideal for investment properties:
- No Owner-Occupancy Requirement – You don’t typically live in the property to qualify for commercial loans, making them well-suited for large multi-family or commercial properties.
- Not Typically Used for Nomading™ or House Hacking – Commercial loans are not usually used for Nomad™ or house hacking strategies, as these financing options are focused on larger, income-generating properties rather than smaller, owner-occupied properties.
Down Payment
Down payment requirements for commercial loans are significantly higher than for residential loans:
- Larger Down Payments – Commercial loans usually require a down payment of 20-30%, depending on the property type and your financial profile. They can require larger down payments to get the DSCR where it needs to be.
- Higher for Riskier Properties – Riskier property types, such as mixed-use or retail spaces, may require a down payment of 30-35%.
Loan-to-Value (LTV) Ratio
The LTV ratio for commercial loans is more conservative compared to residential loans:
- Standard LTV – The typical maximum LTV for commercial loans is 70-80%, meaning you’ll need 20-30% equity in the property.
- Lower LTV for Higher Risk – For riskier properties or borrowers with weaker financials, the LTV may be capped at 65-70%.
Interest Rates
Commercial loans offer a mix of fixed and adjustable rates, but interest rates tend to be higher than residential loans:
- Adjustable-Rate Loans – Many commercial loans are adjustable, with rates that reset after an initial fixed period of three, five, or seven years. This can add additional risk to investing in properties with these types of loans over loans that do not have adjustable rate loans.
- Higher Rates – Commercial loan interest rates are typically higher than those for residential properties, often ranging from 4-7% depending on market conditions and the borrower’s profile.
Amortization Period
The amortization periods for commercial loans can vary, but most come with shorter loan terms:
- 20-30 Year Amortization – Commercial loans typically have 20-30 year amortization schedules but shorter loan terms, often requiring a balloon payment after five, seven, or 10 years. This can add additional risk to investing in properties with these types of loans over loans that do not have balloon payments.
- Shorter-Term Loans – Some commercial loans have even shorter terms, such as 15 years, which results in larger monthly payments but allows you to pay off the loan faster.
Private Mortgage Insurance (PMI)
PMI does not apply to commercial loans:
- No PMI – Since commercial loans generally require larger down payments, there is no PMI requirement.
Loan Limits
Commercial loans have higher limits than residential loans but are also dependent on the borrower’s ability to qualify:
- Larger Loan Amounts – Commercial lenders may offer loans ranging from $500,000 to tens of millions, depending on the property and borrower’s financial profile.
- Flexible Loan Limits – Unlike residential loans, there are no set limits based on government guidelines, but your ability to qualify is key.
Number of Loans Allowed
Commercial lenders don’t impose strict limits on the number of loans you can have:
- No Limit on Loans – There is typically no limit on the number of commercial loans you can hold, as long as you can demonstrate the financial ability to manage multiple properties and debt.
- Commercial Loans and Traditional Loan Limits – Commercial loans do not count toward the limit of financed properties for conventional loans, allowing investors to potentially hold multiple commercial properties alongside their residential investments.
Seller Concessions
Seller concessions may be limited with commercial loans:
- Negotiated Seller Concessions – While seller concessions are less common in commercial transactions, they can be negotiated based on the terms of the deal. However, the lender may cap the amount that can be applied to closing costs.
Waiting Period After Major Financial Events
Commercial lenders may be more flexible when it comes to waiting periods:
- Bankruptcy Waiting Period – Many commercial lenders require a two- to four-year waiting period after bankruptcy, but exceptions may be made based on your current financials and the property’s income potential.
- Foreclosure Waiting Period – A similar two- to four-year waiting period applies for foreclosures, though commercial lenders often evaluate these cases individually.
Refinancing Rules
Commercial refinancing is available but can vary widely depending on the lender:
- Rate/Term Refinance – You can refinance to adjust your rate or term, but many commercial lenders require a longer seasoning period compared to residential loans. Pre-payment penalties may apply, which can impact your ability to refinance early without incurring significant fees.
- Cash-Out Refinance – Commercial cash-out refinances are available, but they tend to have stricter requirements. The maximum LTV is usually around 65-70%, and any pre-payment penalties could reduce the feasibility of a cash-out refinance early in the loan term.
- Recast – Commercial loans typically do not offer recasting options, but it’s worth discussing this with your lender to see if exceptions exist.
- Pre-Payment Penalties – Many commercial loans include pre-payment penalties, which can make it costly to refinance or sell the property early. These penalties are often in place for a set number of years and decrease over time, so you’ll need to factor this in when planning to refinance or sell.
Property Types Eligible
Commercial loans are used for a wide variety of property types:
- Multi-Family and Commercial Properties – Commercial financing is typically used for properties with five or more units, retail spaces, office buildings, and mixed-use properties.
- Specialty Properties – Lenders may also provide financing for specialty properties, such as hotels, storage units, or medical facilities, but these often come with higher down payment and interest rate requirements.
Special Loan Features
Commercial loans come with unique features tailored to larger transactions:
- Balloon Payments – Many commercial loans require a balloon payment at the end of the loan term, meaning you’ll need to refinance or pay off the balance in a lump sum.
- Buying In Entities – Many commercial lenders allow you to buy in the name of an entity like an LLC. Most will require you—or someone else—to sign and personally guarantee the loan even if you’re buying in an LLC or other entity. If you find a lender that offers a non-recourse loan (no personal guarantee), expect to make a down payment of 35% or more.
- Flexible Terms – Commercial loans are often tailored to the borrower’s needs, offering a range of terms and repayment structures depending on the property and financial situation.
Approval and Underwriting Process
The commercial loan approval process is more complex than residential loans:
- More Rigorous Underwriting – Commercial loans undergo rigorous underwriting, where the lender evaluates not just your financials but also the income-generating potential of the property. They’ll examine rent rolls, vacancy rates, and operating expenses.
- Loan Committee Approval – Larger commercial loans often need approval from a loan committee, which may take longer than the typical residential underwriting process.
Risks and Considerations
There are specific risks and considerations with commercial loans:
- Balloon Payments – Many commercial loans come with balloon payments, meaning you’ll need to refinance or sell the property to avoid paying a large lump sum at the end of the loan term.
- Higher Down Payments and Rates – Commercial loans often require higher down payments and come with higher interest rates compared to residential loans, which can impact your cash flow.