By: Paul Long
Many people don’t realize that there are more options than just a traditional mortgage loan to purchase a Single Family Home, Duplex, Triplex and 4-Plex that would be used as a rental. Most people thing think that any property over 4 units needs a commercial loan (which is true), but you can also do it for those under four. Generally speaking getting a traditional mortgage to finance your first 4 investment properties is fairly easy if you have the down payment and should be used as a primary source of funding.
Where investors get stuck is when you have more than 4 properties. Most conventional mortgage programs will prevent you from going beyond four financed rental properties. Once you get to this point the bank/government sees you as a true investor and that you are a business.
If this is you, then welcome to the Commercial side.
How do Commercial Loans work?
Commercial loans are different than your traditional mortgage loan that you got on your primary residence. These products help investors small or large grow their portfolio. Commercial loans for rental properties generally can be found at smaller banks. This is a good thing because 99.9% of all commercial loans are held with the bank that financed it, so you don’t have to worry about getting that notice that your loan was sold (again!) and you can always talk to your banker if there is an issue, not an 800 number.
Commercials loans are flexible based on the type of property and the number of other loans/properties you have. Commercial Loans can also assist when you want to put your investment in an LLC to protect your personal assets.
Author Note: Talk to your Attorney, but I strongly suggest that all investors put their properties into LLC’s to separate liability from personal and the business. Commercial Loans are generally made to an LLC with personal guarantees from owners.
So what do I need to know about commercial loans?
Just like any loan program there are differences in each program.
- There are not any “30 year fixed” money available for commercial loans. Entity’s like Fanny and Freddie are the reason why you can get long term fixed rate money. Since most commercial loans are held with the bank and not sold, there is no long term money like in conventional mortgage financing.
- Interest rates on commercial loans are slightly higher, depending on the bank and risk profile, rates can range from 1-3% higher than traditional mortgage rates.
- Interest rate is generally fixed for 5 years and after the 5 years are over your rate will adjust and be fixed for another 5 after that. There are many different base rates that are used, so check with your bank on what they use. Make sure to do your own research to see how that base rate has performed during high and low economic times.
- Just like mortgage loans in Canada, there is a balloon payment or “call”. This means that the loan balance is due anywhere from 5-10 years. The bank uses this time to get a new appraisal make sure the property is still performing and that you haven’t gone bankrupt.
- Even though you may not be able to get a fixed rate for 30 years, you can still have payments usually based on 30 years, so your payments should be manageable.
- Down payments are traditionally the same as conventional at 15%-25%. The larger the down payment the more the banker will rush your file to the top of the pile.
- When underwriting a commercial loan bankers are seeking how this loan will be repaid by the cash flow of the subject property. In regular conventional mortgages the focus is on total personal Debt to Income (DTI) (total monthly debt by monthly income) if you are over 45-50% then banks will turn you down. This is another reason why commercial loans could be a good solution. Commercial loans look for cash flow, not Debt to Income.
In closing, what is the same about residential and commercial loans is banks are still looking for good credit, no bankruptcies, judgments etc. Banks look at investment properties as if things go south, you would probably give the investment property back to the bank before your primary house. That is why rates and some down payments could be higher, we look for how much “shirt in the game” the borrower has.