Choosing between Conventional Loans and Commercial Loans

The fundamental difference between commercial real estate loans and consumer home loans is the size of the loan and the intended use.

Conventional loans can only be used for residential properties with one to four units – single-family homes, duplexes, and quadruplexes. According to the standards regulated by Fannie Mae, the maximum number of allowable, simultaneously conventionally financed properties is ten. However, most lenders will only underwrite up to five properties because of risk and the complexity of underwriting. Above five properties, you may want to start looking for a commercial loan that will offer more flexibility for financing as well as additional funding options.

Commercial loans are used to purchase buildings that don’t fall in the 1-4 family category above – properties with five or more units, apartment complexes, mixed-use properties, office buildings, retail spaces, warehouses, and other special-purpose buildings. Commercial loans are also commonly used to purchase real estate portfolios. In some cases you can even get commercial loans for the smaller 2-4 family purchases.

Conventional loan basics

If you’re already a homeowner, you’re probably somewhat familiar with conventional loans. A conventional loan for an investment property is very similar to a primary residence mortgage. Here’s what you should keep in mind about conventional loans for investment properties:

• When you apply for a conventional loan, the lender will look closely at your personal finances. They’ll want to see your income, credit history, and personal debts.

• Lenders will want to see you put down at least 20-25% for investment properties. Compare this to the low 3-5% down payment minimum requirement for a primary residence loan.

• Conventional loans are typically repaid over 30-year terms and offer longer fixed rate options.

• Interest rates for investment properties are usually higher than a primary residence loan and generally lower than a commercial loan.

Commercial Loan basics

Commercial real estate loans come in many shapes and sizes. Their flexibility makes them the loan of choice for investors.

• Commercial loans are based on the financials of the property and not generally the borrowers personal financials.

• Down payment requirements depend on the loan type and the lender. Some commercial loans may have a 15% down payment minimum, while others may be as high as 35%.

• Commercial loans typically have a much shorter repayment period. Instead of spreading out payments over 30 years, be prepared for 10 to 20-year terms.

• Interest rates will depend on the loan product but are usually higher than conventional loans.

• Commercial loans have prepayment penalties and will be a combination of a shorter fixed rate period with an adjustable rate.

Because the needs of commercial investors can be so unique, it’s important to work with a lender with plenty of commercial lending experience. They can help you craft a loan that works with your specific situation.

Qualifying for a Loan

Investing with your own cash might seem like the route to go — but I always advise my investors to use someone else’s money! Borrowing allows you to get more for your money — if you have a certain amount of cash to spend, you can divide that money into multiple down payments on multiple properties, which spreads your money further. As those properties begin to cash flow, you can pay down the loan and increase your cash flow or borrow against the equity for additional purchases.

In addition to securing the money for a down payment, your credit score and debt-to-income ratio will matter; but when it comes to investment properties, lenders are also looking at your assets and reserves. Every lender is different, but most will check for three to six month’s worth of liquid reserves in your account.

Before you start applying for a loan be sure to gather the following items:

• Tax returns

• W2s

• Bank Statements

• Rent Roll and P&L statements for the property you intend to purchase

Where to get a loan

Reach out to your real estate broker or financial advisor — chances are they have someone they trust and regularly work with. They can advise you on which loan makes the most sense for your investment goals. They should be able to help you navigate both conventional and commercial loan options and direct you to various lenders.

It is very important to secure your financing BEFORE you begin shopping for your next investment. You will want to talk to several lenders to find the best deal and terms so you can make sure they align with your investment goals. Taking the time to do things in the right order can be the difference between growing your passive income or buying the wrong property and losing money. With the right guidance you will be well on your way to growing your investment portfolio!

This information may not be used as a substitute for financial advice and you should consult your financial advisor or mortgage lender for financial advice if you have any questions relating to this advisor guide.