Do You Understand the Critical Differences Between a Residential and a Commercial Mortgage, Like the Ones Used to Purchase Multifamily Real Estate?

If you are planning on buying multifamily property with 5 or more units, it’s considered a commercial property, not a residential one. You must get a commercial mortgage, not a residential one. If you’re planning to buy 5+ unit properties and you analyze them with a residential mortgage in mind, you’re in for a big, big surprise.

KEY DIFFERENCE NO. 1: LOAN TERM.

Residential mortgages are typically 15 or 30 years and pay down to zero balance over that time. However, commercial mortgages are almost never more than 10 years long. More typically, they are 5 or 7 years long. In any case, you have a balloon payment at the end and must refinance the mortgage or the lender will foreclose.

KEY DIFFERENCE NO. 2: PREPAYMENT.

You can prepay a residential mortgage with no penalty in most cases. However, most commercial mortgages cannot be prepaid, except within the last six months of the term. Thus, you must find a buyer willing to assume the balance of the loan. With some loans, the loan may not be “resized” or have second mortgages added, so that the buyer must put up more equity to buy the property from you, potentially lowering your sale price and your returns.

KEY DIFFERENCE NO 3: EXPERIENCE.

Residential lenders don’t care if you have experience owning a home or not. However, many commercial lenders will not lend to you if you do not already have experience owning commercial property.

So, what do you do if you lack the necessary experience for a lender to give you a commercial mortgage?

Team Up. You must find a partner who has the requisite experience in commercial loans to co-sign the debt with you and be on the management team. As long as the team has the right experience, the lender will feel comfortable. Also, having an approved management company will help – and, in some cases, will be a requirement of the loan.

KEY DIFFERENCE NO 4: NET WORTH.

This may be the most important difference between residential and commercial mortgages. With a residential mortgage, the lender is looking at the value of the property and your ability to make the payments. However, with a commercial mortgage, the lender is looking not just at those things, but also your net worth, other than the property itself.

So, just because you have $100,000 in cash for a downpayment doesn’t mean you can buy a $400,000, 5-unit property. If you do not have a net worth equal to or greater than $300,000, with $30,000 in cash, the lender will not give you the mortgage, no matter how good a deal it is.

If you don’t have the necessary net worth, what do you do?

The answer here again is to team up. Fortunately, the lender will look at the combined net worth of the entire sponsorship team. So, if you don’t have the net worth but you can partner with one or more people and get the requisite net worth combined, you can get the debt. You will have to pay them or give them a piece of the equity of the deal, but there are definitely people out there who are willing to partner with you in these cases, so don’t be discouraged if you lack the net worth to do it on your own!

 

Feature post photo by Evelyn Paris on Unsplash.com

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