What To Know Before You Refinance Commercial Property
When you refinance commercial property, you swap the existing mortgage for a new loan to lower the monthly payments, change the loan terms, or tap the property’s equity to make improvements or add new commercial properties to your portfolio.
Before you refinance a business property, it’s important to understand the various costs, lending requirements and how lenders evaluate your situation to determine whether refinancing will actually improve your finances.
- Refinancing commercial property can be done for savings (e.g., lowering monthly payments) or for expansion (e.g., buying new properties).
- The costs of refinancing commercial real estate include loan origination fees and appraisal fees.
- Eligibility requirements vary by the lender and loan type, but you usually need to have a strong credit score, a debt service coverage ratio (DSCR) of at least 1.25 and 20% to 40% equity.
What does it mean to refinance commercial property?
In the real estate world, commercial property is a building or land that is used for business purposes. This includes office buildings, industrial properties, retail spaces and multifamily housing, like apartment buildings.
At its core, a commercial loan refinance is very similar to refinancing a mortgage on a residential property. The process involves replacing your current loan with a new one.
Typically, borrowers refinance their loans when they can qualify for more favorable terms, such as a lower business interest rate or a different loan type. Refinancing can also help property owners convert equity into cash to improve cash flow.
Although many homeowners buy investment properties for business reasons — to make a profit by collecting rent from tenants — a rental property isn’t considered commercial property unless it has five or more units. It can be more challenging to refinance a commercial loan, since commercial lenders tend to have stricter requirements than residential lenders.
Pros and cons of refinancing a business property
Pros
- You may be able to lower your monthly payment. The main reason why people choose to refinance is to lower their monthly payments. Typically, this can be done by securing a lower mortgage rate than your current loan.
- You might get better loan terms. Shortening or lengthening the loan repayment term or changing the loan type can also be beneficial if you own commercial real estate. For example, if you currently have an adjustable-rate loan, refinancing into a fixed-rate loan may help provide more stable payments if rates rise.
- You can try to avoid a hefty balloon payment. Balloon payments (large, lump-sum payments for the remainder of a loan amount) are an option for commercial loans. The reason is that commercial loans often have shorter repayment periods than traditional mortgages — usually five to 10 years — and are amortized over smaller periods, leaving a large payment when the loan comes due. Refinancing business property can help you avoid making such a big payment at one time.
- You can borrow money tax-free with a cash-out refinance. With a cash-out refinance on a commercial property loan, you borrow more money than you currently owe and get the difference between the two loan amounts in cash. Many commercial real estate investors use the cash to make improvements or buy new investment properties.
Cons
- You’ll pay hefty upfront costs. Just like when you took out your original loan, refinancing a commercial property will come with closing costs. Make sure that the savings from your new loan will outweigh the cost of any fees you’ll pay up front.
- You may not be able to refinance all types of commercial property loans. The rules about which commercial property loans can be refinanced are complex and subject to change. Check in with your lender to see if your current loan program has any restrictions.
- You could face a prepayment penalty from your former lender. Some lenders — including the U.S. Small Business Administration (SBA) — charge a prepayment penalty for paying off your loan early, which can add to your costs.
Should you refinance your commercial property?
Refinancing can make sense if:
- You can secure a lower rate than your current loan
- Your property’s value has increased significantly
- You need to improve cash flow or access equity
It won’t make sense if:
- Prepayment penalties outweigh potential savings
- Your property income (net operating income or NOI) has declined
- You plan to sell the property soon
Commercial property refinance loan types
Government-backed refinance loans
What it is: This type of refinance loan is backed by a government agency like the SBA or the U.S. Department of Agriculture (USDA). The SBA offers loans up to $5.5 million, while USDA loans go up to $25 million.
How it works: The refinancing process works like any other, except in this case, the SBA and USDA agree to guarantee a portion of the loan amount if the borrower defaults (fails to repay the loan). This guarantee makes it easier for lenders to offer borrowers flexible qualifying standards, which in turn makes these loans more accessible to more people.
Who’s eligible: In order to refinance into an SBA loan, you must have equity in your for-profit business of a suitable size operating in the United States. You’ll also have to show that you’ve been in operation for at least two years, as well as demonstrate that you can’t get funding elsewhere. For a USDA loan, the business must be located in a rural area, and the business owner must be a U.S. citizen or have permanent residency status. You can check your business’s location using the USDA’s property eligibility tool.
Conventional commercial refinance loans
What it is: A conventional loan is any mortgage that’s not backed by the federal government. Conventional commercial mortgages typically come from a traditional bank or mortgage lender. Commercial loans don’t often have specific loan limits — instead, lenders allow you to borrow a certain percentage of the value of the property that acts as collateral. They usually allow a loan-to-value (LTV) ratio of 70% to 75%. According to guidelines set by the Office of the Comptroller of the Currency, the maximum LTV ratio shouldn’t exceed 85%.
How it works: With this option, a borrower can switch to a loan with a different interest rate, a different type of interest (fixed versus adjustable) or a shorter loan term.
Who’s eligible: Conventional commercial loans usually have stricter requirements than government-backed loans. You may face higher credit score requirements, lower maximum LTV ratios and shorter loan terms (which means more expensive monthly payments that are more difficult to qualify for). Compared to SBA or USDA loans, conventional commercial loans are geared toward more established business owners who can meet these tougher borrowing requirements.
Commercial cash-out refinance loans
What it is: A cash-out refinance commercial loan allows you to replace your existing mortgage with a new one by borrowing more money than you currently owe on the property.
How it works: Once you’re approved for a cash-out refinance commercial loan, the difference between the new loan amount and how much you owe on the property is paid to you in cash at closing. You can expect to access around 75% of the refinanced property’s value in cash.
Who’s eligible: This type of refinance loan is best suited for those who have built up a substantial amount of equity in the property. Commercial lenders typically require you to have 30% to 40% equity in the property before they’ll allow you to take cash out.
Commercial property refinance interest rates
Although the refinance rates you are offered will vary depending on the lender, your business’s attributes and your credit profile, you can expect to see the lowest rates with government-backed SBA and USDA loans, followed by conventional loans.
SBA loans may be especially attractive when interest rates on commercial property are rising because they offer competitive interest rates and fees and come in both fixed and variable rates. You are able to refinance existing SBA 504 loans, but refinancing existing debt into a new 504 loan is not permitted.
Requirements to refinance commercial property
Once you’re aware of which type of commercial loan you need, it’s important to get a sense of the requirements for refinancing. Here’s an overview of some key guidelines:
- Credit score. A business credit score is different from a personal FICO credit score. In general, lenders look for this score to be as high as possible. The SBA generally looks for a minimum FICO Small Business Scoring Service (SBSS) score of 165 to approve someone for an SBA 7(a) loan, but there may be exceptions. For a non-government loan, credit score requirements vary by lender.
- Net operating income (NOI). Net operating income is a measure of a property’s gross income minus its operating expenses, not including debts and income taxes. As a rule of thumb, the greater the NOI, the better your chances of commercial loan refinance approval. NOI requirements will vary by lender and loan program, depending on the type of business and the property size.
- Debt service coverage ratio (DSCR). In real estate, DSCR is a measure of the cash flow a business has available to pay its debts. In this equation, a ratio greater than one indicates that the company is generating enough revenue to cover its debts, so lenders usually look for a minimum of 1.25, but prefer something closer to 2.00.
- Operating history. Lenders generally prefer to see at least a few years of stable operating history to prove that the business is sustainable.
Here are some of the documents a lender may want along with your loan application:
- Business name and address
- Tax returns
- Employer identification number (EIN)
- Business plan
- Profit and loss statements
- Cash flow forecast
- Proof of collateral
- Bank statements
- Business formation documents
Closing costs and fees when refinancing a commercial property
Before you refinance commercial property, understanding the refinance costs involved can help you decide if it’s worth the effort. Here are a few of the most common closing costs that borrowers face when refinancing commercial real estate:
| Fee type | Typical cost |
|---|---|
| Prepayment penalty
Some lenders charge a penalty fee if you try to pay off your loan early. This fee is used to make up for missed interest payments.
| Varies by lender |
| Guaranty fee
The SBA charges this fee for backing your loan, and lenders pass this cost onto you.
| 0.25% to 3.75% of the guaranteed portion of the loan |
| Credit check fee | $100 to $1,000 |
| Application fee | Varies by lender |
| Origination fee
Many lenders charge an origination fee to offset the costs of completing your loan refinance.
| 0.5% to 1% of the loan amount |
| Appraisal fee | $2,000 to $4,000 |
Tip: Refinancing is typically worth it if your long-term savings exceed your upfront costs.
For example:
- If you pay $20,000 in closing costs and fees but save $500 per month, you’ll break-even in around 40 months.
- If you plan to sell before that, refinancing may not make sense.