Here’s what to know before you talk to a banker
If making the switch from leasing to owning office space is on your mind, deciding if you can afford a commercial mortgage isn’t quite the cut-and-dried question it might seem.
A simple loan calculator can’t replace conversations with a smart commercial banker that knows the finer nuances of conventional versus SBA loans. Plus, their review of your cash flow and operations helps to uncover a truly realistic mortgage budget that helps your bottom line.
That being said, there are a few areas beyond affordability of the initial down payment and monthly mortgage payments to consider before meeting with a lender.
How healthy is the business?
In order to qualify for an owner-occupied commercial mortgage, the business will need to withstand a close financial review of its profit and loss statements, cash flow management, operations, credit history, business plan and more.
The bank will evaluate whether the business can qualify for the loan and comfortably service the debt without straining cash flow. This is good information to have before you begin looking for a commercial property.
The lender looks far deeper than just the value of the property as collateral, too; they expect the business to invest in equity through a large cash down payment to ensure they’re committed to the loan. Terms also vary depending on the strength of the underwriting, the level of down payment and other factors.
These are the types of questions they’re looking to answer:
- What is the business’s credit score?
- How established is the business and can it cover payments when earnings are lean?
- Can it afford a substantial down payment, along with appraisal costs, legal fees, title insurance and other closing expenses?
- If a specific property is in mind, what will the loan-to-value ratio be once the expected down payment is calculated?
- Because banks rarely provide fully amortized financing, what happens when the balloon payment comes due?
- Is it a new purchase or refinancing to pull cash out of the property?
- Does the business have a history of making smart credit decisions and making payments on time?
- Does it have the cash flow required to maintain the property in addition to mortgage payments? Will staffing the new location add further strain to the businesses finances?
Taking time to look at the health and assets of the business before talking to a banker can help you prepare for the meeting, and have a clear picture of its cash flow and what you might be able to afford.
What is the legal structure of the business?
If the business is less established, or a legal entity other than corporation, such as a LLC or partnership, qualifying for a loan isn’t just about the business. It’s about the people, too.
The commercial property might be purchased as a business asset owned by the business entity, but personal finances and creditworthiness of the owner(s) play a part in the process. Because they’ll look at the credit history and global cash flow of the owner or each partner/principal in the business, it’s important to have personal finances in order before approaching the bank.
Personal liability is different, too.
Unlike a home mortgage where the lender’s only recourse is to foreclose on a home and claim the asset, lenders may require certain businesses to provide a personal guarantee which legally obligates the individuals to the loan. The bank may ask the pledge of private assets of the business owner(s) as collateral. If the commercial mortgage defaults, the lender can seek compensation for damages by going after assets of the guarantor. It is a rarity that a bank does not expect business owners to be personally obligated on a commercial loan.
Considering this before applying can be valuable in making the decision to purchase or continue leasing.
Don’t assume it’s comparable to a home mortgage
Commercial mortgages are very different than a home mortgage. The application process, criteria for approval and terms of the loan will be very different.
When someone buys a home, payments are typically arranged in a 30- or 15-year schedule that ends with the entire balance paid off. However, a commercial mortgage usually ranges from five to 15 years, ending in a balloon payment that requires a large infusion of cash or refinancing.
A commercial mortgage also won’t have an amortization period that matches the loan period, since most commercial mortgages are amortized across 15 or 25 years. This amortization, the length of the loan term and the interest rate all impact the size of the monthly payment.
Differences don’t stop there. It’s rare to find a lender willing to finance 100% of a commercial mortgage, so the business should expect to pay a significant cash down payment in addition to standard closing costs.
Because the dollar amount of the loan and the risks are much higher for commercial property than a personal mortgage, the lender expects the business to have a stake in the property. A larger down payment reduces the amount financed while ensuring the business is committed through the equity they hold on the property (calculated by a loan-to-value ratio that divides the loan amount by the value of the property).
Loans with a 65-80 percent LTV ratio are preferred, since a business is far less likely to default on the loan if there’s a major investment of cash in it. Therefore, a business should expect to invest a down payment of 20 to 35 percent.
The LTV required by a lender depends on the type of property, how it will be used, the type of loan financing the purchase and factors established by the lender. These specifics will be discussed in a face-to-face meeting with a lender, but it helps to know how much cash is available beforehand.
Understand why terms fluctuate from lender to lender, or program to program
Whether it’s a large corporation or small firm with a single owner, the amount of lender risk determines terms of a commercial mortgage loan.
Even if the loan includes a government guarantee as a Small Business Administration (SBA) loan or United States Department of Agriculture (USDA) loan, lenders are allowed set their own interest rates and terms based on how comfortable they are with the risk of the loan. More risk means more paperwork, a more stringent approval process and sometimes less attractive terms.
A commercial mortgage for the same property might look very different from one lender to another. Knowing this can help if you’re shopping for the best possible loan.
We’re here for you
As a community bank, we believe in local first and helping our community thrive. We approve more loans and have local decision makers. If you’re considering a commercial mortgage and wondering what you can afford, we’d welcome the opportunity to help. Click here to find your closest branch or loan office.