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Commercial Mortgage Loan Basics

 

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A commercial mortgage is one that is used to fund the purchase of any property that can be used as a business, and generates income for the owners. Whether it is an apartment building, a manufacturing facility, a strip mall, office complex or a small shop house, these are all examples of commercial properties. Due to the level of investment that commercial realty commands, most times funding is sought for the mortgage. It makes good business sense.

In many respects commercial mortgage loans and residential loans are the same; collateral, a good down payment, a healthy credit history and inspections and appraisals are all expected by lenders. What makes them different is the amount of preparation, documentation and leg work that goes into securing a commercial mortgage. Knowing that the income generated by the business will help to repay the loan, lenders are not only interested in the physical property, but its commercial viability. If it is an existing business (not one that is being constructed to spec) then the previous track record of the business will also come into play when applying for a loan to finance the purchase.

Similar to residential mortgage loans, commercial loans can be at a fixed rate, adjustable rate or a combination of the two. By securing a fixed rate, just as if it were a residential loan, you will have the security of knowing that your interest payments are stable and easy to budget with out undue surprises. If you are in a long term amortization program and the rates drop dramatically, just like a residential loan, a commercial fixed rate loan can be refinanced at the newer low rate. While you are paying off your loan the lender makes an income from the interest, if you fail to satisfy your loan agreement, the lender can begin foreclosure proceedings to take back the property because it was put up as collateral.

A variable, or adjustable rate commercial loan, is one where the interest rate is pegged to an interest rate set by the Federal Government. A savvy business person, who is looking to borrow for a mortgage, or who already has one that is a variable rate mortgage, will keep his eye on the rates. Knowing past and current trends, and what influences them, is extremely beneficial to the borrower. Knowing the frequency of rate changes is also good to know.

An example of a combination of these two commercial loan types would be a few years at a fixed rate, and then shifting into a variable rate. This is a good way to establish yourself with the lender if you have a small down payment, below par credit or it is your first business venture. By accepting the fixed rate in the early stages you are less of a risk.

The toughest part of variable rates is forecasting how the rates will change, and what your ability to keep in step with increases will be. If you are not flush with cash, and the rates begin to climb you must be able to keep making your payments or risk foreclosure and repossession.

As time passes, and you start to pay down your debt, you will build equity in your property/business, and as you can with a residential loan, this equity can be a source of improvement funding for your business. These funds can be used to expand, renovate or improve your business and the property. Just be careful that you do not bleed the equity from the property to the point where you might suffer and default. Taking it all step by step, and in a prudent manner is the way to establish, promote and keep the business that you have worked so hard to attain. So many people make the mistake of squandering a good start and reputation by expanding to quickly. What was a dream come true becomes their worst nightmare.

People who are successful, at times, tend to want to pay down quickly and get out of their commercial loan before the amortization process is complete. More often than not, there is a clause in the mortgage that carries a penalty for early payment. Know what this penalty is, analyze the ramifications, and only then decide if it is in the better interest of the business on a whole.


This penalty, that you will be assessed for getting out early, is known as the ERC, or Early Redemption Charge. Lenders are business people whose main goal is profit. If they allow you to pay off your loan quickly they lose income that would have been generated by the interest payments that have now stopped. A sure way to avoid ERC is to negotiate it out of your loan agreement before you sign. If you cannot get it removed from the agreement try to find a lender who will. Shop around, let the lenders know you are shopping around, and look out for your own best interests.

 
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