There are many different types of commercial real estate loans. Here are nine of the most common:
1. Conventional Mortgage-based Loans
This is probably the most popular type of commercial real estate loan and is similar to a residential mortgage. However, unlike typical home mortgages that may have a 30-year repayment schedule, these real estate loans can be much shorter, such as 10 years or less. If you opt for a variable solution, interest rates tend to fluctuate with market trends. If you want more predictability, pick a fixed-rate mortgage where the payment and interest rates will remain the same, month by month.
While the lending company will typically secure the loan against the property, it could choose other collateral, such as property that you may already own elsewhere or a pool of money you might hold in another account.
Terms and conditions will also vary by lender. For example, the lender may require that you have a certain amount of time in business, a minimum personal credit score, or that you intend to use the premises for specific business uses.
2. Seller Financed Loans
You may be able to obtain financing directly from the seller. Much may depend on their motivation and how keen they are to pass on the property. Due to these motivation levels, seller-provided financing may be more attractive than a conventional mortgage-based loan. The seller may be more flexible and negotiate a lower interest rate to get the deal across the line.
You often find this type of loan when buying condominiums or apartment complexes. If the building owner is an individual rather than an institution, they may be more interested in discussing seller finance.
3. Interest-Only Loans
These are often called “balloon” loans and can offer an attractive solution if you want to keep monthly payments as low as possible while you are improving the property. These will work if you anticipate having a significant amount of money at a future date. You’d use this money to pay off the bulk of the advance and will only pay a smaller interest amount in the meantime. These loans tend to be relatively short.
4. Refinancing Loan
A refinancing loan may be appropriate if you already have financing and are looking for a better deal. For example, interest rates may have lowered considerably since you first took out the loan. On the other hand, you may want to expand your current property and would like to use the equity that you have already built up to finance it. Again, you may be able to refinance an existing loan if you need cash to make your balloon payment on an interest-only loan.
5. Hard Loans
This is a more unconventional approach and typically involves private investors rather than mainstream lenders. It may be attractive if you do not have a high credit rating and may struggle to get financing elsewhere. In this case, the private investor may be willing to take a calculated risk based on the property value, but these loans tend to be short-term rather than long-term. They may also carry higher than average interest rates and require certain fees upfront. Some borrowers may look for hard loans if they only intend to keep their property for a short time or are in a time crunch to acquire the property.
6. Bridge Loans
Another short-term loan option is the “bridge,” which may be perfect if you need to renovate a property before it is eligible for a bigger finance deal. Other borrowers may seek a bridge loan for a certain period before improving their credit rating and getting more favorable terms elsewhere. Still, you may have to furnish a 25% or more down payment and need a strong credit score to get this type of loan from a traditional bank.
7. Blanket Loans
You may file these under “specialty” loans that are only appropriate if you have multiple properties you want to cover under one financing arrangement. This may give you flexibility when spending money on individual properties or selling one without penalty, but they often have crushing terms and conditions.
8. SBA 7 (a) Loans
The Small Business Administration offers these loans to companies that need significant working capital, equipment, or commercial real estate. With SBA 7 (a) loans, you can get up to $5 million in financing and repayment terms of up to 25 years (real estate). Interest rates tend to be relatively low in comparison to other forms of borrowing.
The SBA will “guarantee” small business loans, making them easier to get than traditional loans. You need to be able to qualify using strict criteria, and the government will look at various eligibility factors, including location, size of the business, and organizational structure.
9. SBA 504 Loans
In this case, the small business administration teams up with a Community Development Corporation to offer loans for commercial real estate (and equipment purchases). Thus, most of the loan comes from a combination of traditional bank lending and non-profit organizations, while the borrower will have to put down 10% of the total sum.
SBA 504 loans have a maximum value of $5 million as well. The terms and conditions are strict, especially regarding what you can and cannot use the loans for. To qualify, you need to make some accounting calculations, including the all-important “debt service coverage ratio.” This is to ensure you can afford the repayments as part of your other ongoing obligations.