What’s the difference?
The process of financing a loan starts with the simple question, what is the loan for? There isn’t a one size fits all equation to determine the right financing for every need when it comes to real estate. Funding the purchase of a 5,000 square foot home looks different than finding funding for a 5,000 square foot warehouse space. When it comes to financing residential and commercial loans, there are similarities and differences and it can be easy to confuse the two. Understanding what makes them different will help you successfully prepare for the process.
Oftentimes, residential loans are taken through traditional funding methods. This means the loan is granted by a bank or credit union. These are the types of loans most commonly thought of when people consider borrowing money to buy a home. Banks can offer funding for loans determined by factors such as:
- Credit scores
- Loan amounts
- Credit history
Each of these requirements varies from bank to bank. For some borrowers, finding funding through this method can be challenging because of the stringent nature of the bank or CU’s requirements, the length of the loan close cycle, and the requirements for documentation.
According to Forbes, commercial banks approved only 14.3% of submitted loan applications by the end of 2021. Working with our team at Innovative Capital Corporation increases the opportunity to find the right loan for your business needs because we can source to more than commercial banks.
Alternative financing for real estate acquisitions is typically more flexible than traditional banks because they do not have the same regulations governing them. Alternative funding can be an attractive option for commercial loans because of their malleable nature, speed of close, and the ability to collateralize the loan with the investment property being acquired.
Types of alternative financing options include:
- Hard money loan
- Bridge loan
- Crowdfunding
- Asset-based loan
Here at Innovative Capital Corporation, we specialize in sourcing traditional and alternative loan opportunities based on the unique needs of our clients. Through our vast network of lenders, we have the capabilities to understand funding needs on the sides of both the lender and borrower to match the two.
What is the benefit of using Innovative Capital vs going straight to a Bank?
The added benefit of working with Innovative Capital can be best summed up in the time saved, the speed of close, and the convenience of sourcing multiple funding options all at once. Because of our network of lenders and our ability to source multiple loans simultaneously, we are able to streamline the process and give our clients multiple options to choose which loan fits their needs best.
Before choosing if you need a residential or commercial loan for your next investment venture, read on to understand what separates the two, and why knowing the differences is important.
Underwriting
The underwriting process of a loan is the first step. During this time, the underwriter will look at specific indicators to help them paint a picture of what loan amount, rate, and term to grant, and whether or not the borrower is eligible for the loan. By looking at your credit history, the lender is assessing the risk factors involved in agreeing to your lending request.
Residential
For a residential request, the underwriting process is based on the strength of the borrower themselves. Factors such as income, credit history, letters from employers, tax returns, financial statements, and more are taken into consideration.
Commercial
As in a residential loan, the financial expert working with your commercial loan will view multiple factors before assessing final approval. The process is based primarily on the property’s ability to pay the debt along with a global look at the borrower including factors like:
- Property debt service
- Guarantor strength
- Future property performance
- Net worth strength of the sponsors.
Keep in mind that there isn’t one single approach to address the borrower’s eligibility for a commercial loan. Knowing your options on how to structure a loan increases opportunities to find the right funding.
Multifamily
Multifamily properties can be considered both residential and commercial. Their differences lie in the number of units they house and who can fund the loan itself.
Residential
A residential multifamily property is any property that ranges from one to four units. Think more along the lines of a small apartment complex. This means that a mortgage loan officer (MLO) can provide financing for the property.
Commercial
Commercial multifamily properties are considered to be anything with five or more units. This means that a residential MLO would not be able to fund the purchase or refinance of this property. They would need to refer the loan to someone like us at Innovative Capital Corporation who have the ability to fund the deal with private capital or shop for the best loan from our network of commercial lenders.
After Funding
What happens to residential and commercial properties once they are funded? Once funded, both take different directions. Typically, the former is sold and the latter is kept as part of a commercial real estate asset portfolio.
Residential
Residential loans are generally pooled and sold immediately sold on the secondary market to bonding agents, or become portfolio loans that sit on a lender’s Balance Sheet.
Commercial
For commercial lenders, after funding, the loan becomes a portfolio loan. According to Bankrate, “a portfolio loan is a kind of mortgage that a lender originates and retains instead of offloading on the secondary mortgage market.” Instead of being sold immediately, it’s held on and continues to be used until the loan is paid in full.
A major benefit to a portfolio loan is the ability for the lender to provide flexibility in the terms– often in the borrower’s favor because they have retained the loan on their books.
Amortization
Residential
The majority of residential loans are amortized for 30 years. That means the payment plan for the loan is at a fixed rate to be paid off over 30 years. The payments are smaller because they are spread over time, but the borrower will end up paying more in interest. Amortization time frames for residential properties are usually 30/30 or 15/15.
Sometimes, when the borrower wants to pay the loan off quickly to avoid paying more interest, the borrower can set up a 5/30, 7/30 & 10/30. This means that the borrower is paying the loan amount in 5, 7, or 10 years instead of thirty, and minimizing total interest. Be cautious when paying loans early if it is not stated in the agreement because there may be penalties for early repayment as it takes away the interest the lender would have accrued over time.
Commercial
Typical amortization for commercial loans is 25 years with the exception of multifamily properties. Various terms and amortizations are available depending on the lender and borrower agreement. The most common options taken are 5, 7, or 10 year fixed terms on 25 or 30 year amortizations.
Fixed Term
Fixed terms for loans lock in the interest rate for a set amount of time. During the agreed period, which could be a year or last the duration of the loan, the interest rate stays the same and will not fluctuate. The rate is thus “locked in.”
Residential
Usually, residential loans are fixed for the full term of the amortization. If the loan is amortized for 30 years at 2.4%, the interest rate will stay the same for thirty years. There are additional loan scenarios to fit the borrower’s unique needs. We can introduce trusted residential loan specialists if you need additional information.
Commercial
Fixed terms are not as direct for commercial loans. Normally, a commercial loan will have a fixed term for 3-10 years with a balloon payment. Balloon payments allow the borrower to make lower payments in the beginning and then request a larger one-time payment at the end of the loan. Typically, at the end of the loan term and before the balloon payment is due the commercial property will be refinanced and the loan coming due will be paid off. In commercial real estate, refinancing the property happens more frequently due to the shorter terms of 5, 7, 10 years. This also provides the commercial real estate investment opportunity to leverage the property pulling cash out to invest in another property or completing needed maintenance on the subject property.
Learn more
Finding the right funding for your commercial loan relies on a myriad of factors. Having a trusted resource to help you make the right decision is where we can help. Before starting the process, calculate the value of the commercial real estate property by clicking the link here.
