Investing in real estate is an exciting and lucrative option if you have the capital and expertise to pick wise investments. Many investors choose to start with residential properties.
However, if you’re making the jump into commercial real estate, there are a few key differences you need to understand about commercial and residential mortgages.
Amortization and Term
Residential mortgages are designed to allow you to completely pay off the loan within the term limit with monthly payments. However, a commercial mortgage is usually set up differently. With commercial mortgages, you’ll still have payments, but the amortization schedule is shorter, sometimes significantly so. This means that you’ll have a large sum due at the end of your payment plan, even if you’ve been making consistent payments.
Carefully consider the term length before signing. Will you be selling your commercial property before the term has ended? If not, you’ll need to plan on ways to pay off the remaining debt.
Pre-Approvals and Term Sheets
Gone are the days of simple pre-approved loans and house shopping. Commercial real estate mortgages don’t come pre-approved. Instead, you’ll need to choose the property you wish to purchase and put in under contract. You’ll need to sign a term sheet, then seek financing based on those terms.
This makes it slightly more restrictive to choose a commercial investment. You’ll need to carefully research each option and commit to one before receiving a mortgage.
Penalties for Prepayment
A common strategy for residential mortgages is to pay them off as quickly as possible in order to avoid interest. A commercial mortgage almost always comes with prepayment penalties. In order words, you rarely come out ahead if you attempt to quickly pay off a mortgage. Most are designed with stability in mind, so you’re committing to stick with your loan to the end.
Levels of Recourse
The biggest risk in commercial real estate investing is the level of recourse. Residential investors only have to fear losing their investment property. Commercial investors, on the other hand, can also lose a significant amount of personal finances. If you’re unable to pay back your mortgage, you may lose even more than you originally took out.
Branching out into commercial real estate can still be an exciting and profitable venture. With these differences in mind, carefully research the type of property and mortgage that best fits into your investment portfolio and overall business plan.