The buyer of a $200,000 home with a 30-year fixed-rate mortgage at 3%, for example, would make 360 monthly payments of $1,027, after which the loan would be fully paid. These figures assume a 20% down payment.?
Unlike residential loans, the terms of commercial loans typically range from five years (or less) to 20 years, and the amortization period is often longer than the term of the loan. A lender, for example, might make a commercial loan for a term of seven years with an amortization period of 30 years. In this situation, the investor would make payments for seven years of an amount based on the loan being paid off over 30 years, followed by one final “balloon” payment of the entire remaining balance on the loan.
For example, an investor with a $1 million commercial loan at 7% would make monthly payments of $6, for seven years, followed by a final balloon payment of $918, that would pay off the loan in full.
Depending on the investor’s credit strength, these terms may be negotiable. In general, the longer the loan repayment schedule, the higher the interest rate.
Loan-to-Value Ratios
Another way that commercial and residential loans differ is in the loan-to-value ratio (LTV), a figure that measures the value of a loan against the value of the property. A lender calculates LTV by dividing the amount of the loan by the lesser of the property’s appraised value or its purchase price. For example, the LTV for a $90,000 loan on a $100,000 property would be 90% ($90,000 ? $100,000 = 0.9, or 90%).
For both commercial and residential loans, borrowers with lower LTVs will qualify for more favorable financing rates than those with higher LTVs. The reason: They have more equity (or stake) in the property, which equals less risk in the eyes of the lender.
High LTVs are allowed for certain residential mortgages: Up to 100% LTV is allowed for VA and USDA loans; up to 96.5% for FHA loans (loans that are insured by the Federal Housing Administration); and up to 95% for conventional loans (those guaranteed by Fannie Mae or Freddie Mac).???
Commercial loan LTVs, in contrast, generally fall into the 65% to 80% range.?? While some loans may be made at higher LTVs, they are less common. The specific LTV often depends on the loan category. For example, a maximum ca payday loans online LTV of 65% may be allowed for raw land, while an LTV of up to 80% might be acceptable for a multifamily construction.
There are no VA or FHA programs in commercial lending, and no private mortgage insurance. Therefore, lenders have no insurance to cover borrower default and must rely on the real property pledged as security.
Debt-Service Coverage Ratio
Commercial lenders also look at the debt-service coverage ratio (DSCR), which compares a property’s annual net operating income (NOI) to its annual mortgage debt service (including principal and interest), measuring the property’s ability to service its debt. It is calculated by dividing the NOI by the annual debt service.
For example, a property with $140,000 in NOI and $100,000 in annual mortgage debt service would have a DSCR of 1.4 ($140,000 ? $100,000 = 1.4). The ratio helps lenders determine the maximum loan size based on the cash flow generated by the property.
A DSCR of less than 1 indicates a negative cash flow. For example, a DSCR of .92 means that there is only enough NOI to cover 92% of annual debt service. In general, commercial lenders look for DSCRs of at least 1.25 to ensure adequate cash flow.
