How to Find the Best Commercial Mortgage for Your Business
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Finding the business mortgage that’s a perfect fit for your funding needs can be challenging. There are so many different options for a business owner to pursue, and it’s difficult to know which type of financing is going to best suit your short- and long-term financial needs.
What is a commercial mortgage?
A commercial mortgage loan, also called a business mortgage loan, is used to fund the purchase of an existing space for your business or lot where you plan to build your business’s new location. These loans are exclusively for commercial real estate, which means you can’t use them to purchase residential properties.
Business owners often take out commercial mortgages to cover the costs of purchasing commercial property, renovating an existing office space, or upgrading their business’s appliances and machinery. For example, you can use a commercial property loan to cover the cost of land and construction for a new business complex, or to expand your restaurant’s kitchen and upgrade appliances.
How do commercial mortgage loans work?
Many of us have experience with mortgages through the purchase of a home or land. Commercial mortgages work differently than a traditional home mortgage.
Commercial mortgages through a traditional bank often require a down payment of 20 to 30 percent, a higher amount than a residential mortgage. The property you’re purchasing acts as collateral for the loan, and the lender will require a lien that protects them in case you, the borrower, defaults. A lien is the legal right that a property owner gives to a lender that serves as a guarantee for the repayment of your commercial mortgage.
Average business mortgage rates will start at a similar percentage as five to 10 year Treasury note yields, but can be higher. SBA loans will typically have low interest rates and you’ll find notably higher interest rates with bridge loans or short-term financing for a commercial property purchase. Additionally, you should anticipate a range of mortgage features that add to your total cost including appraisal charges, legal fees, application fees, survey charges and the potential for a “balloon” payment that’s calculated into your mortgage terms.
Property purchasers can obtain a business mortgage loan through traditional banks, as well as non-bank lenders such as silent investors or the U.S. Small Business Administration. Once you apply, get approved and secure your lien, you’ll enter your repayment period.
Real estate financing has different expectations than residential real estate financing. When you purchase a home with a 30-year mortgage, you’re expected to pay the mortgage off in 30 years. This isn’t always the case with commercial mortgage loans. There are usually two types of repayment schedules that a commercial mortgage can follow:
- Traditional amortized loans, where you pay a set amount each month for a set period of time
- A mortgage with a “balloon” payment
In the case of a balloon payment mortgage, your commercial mortgage will be set up with the expectation that you’ll pay the loan off in full after a set number of years. Keep in mind that lenders need to be cautious who they approve for a commercial mortgage. The risk that lenders take if a business goes under and fails to repay their mortgage is high, which is why they require high interest rates, extensive background and credit checks, and accelerated payment terms in comparison to a home mortgage.
How to apply for commercial business loans
You’ll need to walk into the commercial mortgage application process with patience and an open mind. Things don’t often go as smoothly as they would if you were purchasing a residential property and the process may take longer than expected.
Lenders will first check to see if you qualify. Your lender will evaluate the business property you’re looking to purchase, and they’ll likely do a deep-dive into your business credit, business best practices and financial records. While this may seem excessive or invasive, it’s just the lender’s way of protecting themselves against the risk of lending to an unknown business.
Applicants often receive a preliminary approval in one to two business days, but the lender will take 10 to 20 business days to run their background checks and investigate your business to move forward with the application process. In fact, the processing period for your commercial mortgage could take many months, so be ready to wait it out. Several documents may be required, including:
- 3-5 years of tax returns and financial statements
- Corporate documents
- Asset statements
- Personal financial records for all owners of the business
Every lender is a little bit different and may have a unique set of requirements. The lender will order an appraisal of the property you’re looking to purchase and then write a term sheet. Your term sheet is a declaration of interest from a commercial lender and will outline an estimate of the terms you can expect from your commercial mortgage.
Find the best commercial financing
A commercial mortgage is a big investment, and you deserve to find the best financing that fits your unique business needs. Knowing your options is the first step to understanding the best financing and terms for you.
The SBA 7(a) loan is a general loan for small business owners and can cover commercial real estate purchases. If you can demonstrate that you need funding and have a sound business plan, the SBA 7(a) is likely a good fit for you. However, you must qualify as a small business according to SBA’s size standards, and you need to prove that you’ve used other financial resources before applying for a loan (including personal capital).
The 7(a) loan program is flexible, with long-term repayment schedules and low interest rates. These small business loans allow you to borrow up to $5 million to fund startup costs, purchase property, cover construction costs and more.
504 SBA loan
The Small Business Association’s 504 loan is an ideal fit for many small business owners who may not have a large cash reserve for a large down payment up front. The SBA only requires a 10 percent down payment of the total project cost and offers a fixed rate for a set period of time. It also offers low interest rates.
The SBA’s 504 loan is a great option for small businesses that are looking to purchase modest commercial property, renovate an existing property up to $1,000,000, and can’t afford a high down payment or a balloon payment in five to 10 years. However, if you’re the owner of a larger business or looking to purchase an expensive property, this loan may not be large enough to cover your needs.
Commercial bridge loan
A commercial bridge loan may be right for you if you’re looking for short-term financing while transitioning from one property to another, or if you’re interested in quickly flipping the new property. These loans are ideal if you need to make a purchase quickly and expect to look for more affordable long-term financing once the property is secured. However, because these loans are intended to be short-term, the borrower is expected to either pay them off in full when they mature or roll them into a different financing program. These loans are typically six- to 12-month terms with higher interest rates than that of a traditional mortgage, and you need some type of equity to use as collateral.
Commercial hard money loan
A commercial hard money loan is a loan from a private lender. These loans often have more lax eligibility requirements, which is great for a business owner with a spotty financial background or a small down payment. However, these loans can charge higher-than-average interest rates. Like bridge loans, they’re quick to obtain, but are usually set up to be short-term loans that only exist until you can find more adequate long-term funding.
Traditional commercial mortgage
Traditional commercial real estate loans come directly from a bank. Most people explore this option first and are often surprised by the strict eligibility requirements. It’s important to remember to read the terms of your traditional mortgage carefully so you’re not caught off-guard by unexpected costs and fees masked within your agreement. Banks usually have more cash flow to offer borrowers, so they can often offer a larger loan amount (sometimes up to $1 million) at a lower interest rate. However, their eligibility requirements and loan terms may not be a good fit for you if you’re a small business owner with limited cash flow and average business credit.
The bottom line
Finding a commercial mortgage that matches your business’s financial needs and helps you to secure your ideal commercial property can be a challenge, but it’s certainly not impossible. The good news is that you have many different resources available to you. Make sure you take your time looking at all of your options before choosing a method of financing, and be patient — the process can take longer than expected.