The Difference Between Commercial and Residential Loans

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Commercial and Residential Loans

Taking out a loan to buy a property already takes a lot of consideration, but it’s also essential to know which exact loan you need. Mortgages for business versus those for a home have distinct differences, and it’s necessary to keep these in mind, especially if you’re scouting for financing.

It should be noted that laws per state change some variables, whether you’re looking to invest or you’re a first-time homebuyer seeking a loan. For example, Houston would fall under Texas’ interest rate laws that statutorily get limited to 6%. On the other hand, New York would allow for an interest rate of up to 16%. Aside from that, the points below should clarify the core differences to take note of between commercial and residential property loans.

Liability and Ownership

Commercial:

  • Loans are given to legally recognized business entities. This means ownership and liability fall to your business assets. LLCs, limited partnerships, funds, and corporations fall under this spectrum. However, sole proprietors should take note that they still hold personal liability for debts built from this type of loan.
  • Approval for commercial loans usually requires businesses to occupy at least 51% of the property that they plan to take on. As for requirements, lenders will look at the net operating income of your business, your business credit, commercial tax history, and even your personal credit.
  • In terms of liability, your business assets will be on the line. If your mortgage payments aren’t being paid and you have already deferred them, lenders can take any collateral you’ve set as a settlement. In some cases, if you aren’t able to agree on terms, lenders can even sue your business.

Residential:

  • This type of loan is made to you personally as the borrower. While you claim sole ownership and personal use, this also means you have total liability.
  • Lenders will look at your credit history and look over your tax records to see if you qualify. Pre-approval takes anywhere from a month to two, and here lenders will look at proof of income, assets, and employment. After basing your interest rate and loan amount from that assessment, final approval will mostly depend on your ability to pay, your monthly payments, credit status, and expected income.
  • If you cannot pay mortgage fees for over four months, your home will be up for foreclosure. Because this is a personal loan, it will also impact your credit score.

Payment Terms and Amortization

Commercial:

  • It is often stated that commercial mortgages are more ‘structured’ than residential loans. The loan term for commercial property loans usually varies from their amortization time. The latter is commonly longer than the former, and lenders even carry prepayment penalties.
  • Instead of paying from your own personal funds, a business loan will usually use diverse financinglike a business line of credit and its income stream.
  • Refinancing is also an option here since the amortization time, and loan terms often require businesses to pay off their debts more efficiently.

Residential:

  • Usually, terms are settled between the lender and borrower during the pre-approval phase and before final approval. From there, you repay your loan monthly over a set time with a fixed interest rate. Lenders usually provide a grace period for borrowers in case they need a little more time to pay their debts beyond the set date.
  • Typical timelines see a five-year term with a 25 to 30 year amortization period. A home buyer can choose a more extended amortization period to lower their monthly payments despite having a higher overall debt because of interest. Shorter amortization will require significantly higher monthly payments, but interest rates are usually lower and result in more savings.

Risk and Value

Both types of mortgages carry a certain Loan-to-Value ratio that is largely dependent on the actual property. In either case, this is a significant number to know as it can inform how much risk-taking a loan out for the property will be.

It should be noted that fixed-rate loans are generally deemed safer because they provide a consistent payment scheme to follow. If you’re thinking about liability, residential may seem riskier because it affects your personal assets. However, residential loans typically take your ability to pay into account. On the other hand, commercial mortgages are dependent on the income that your business will produce. In that sense, the risk is higher because you may not anticipate how much your business will make.

With this information, you should make a more informed decision on the type of loan you would need to take out.