Investing in commercial property might sound like a dream come true, but there is more to it than one might think. With so many different types of loans and properties available, it can be hard to know the best option for your needs.
Interested in learning more? Read on to learn about some common property loans you may encounter when investing in commercial real estate.
Secured Vs. Unsecured Loans
Investment property loans can be broken down into two categories: secured and unsecured.
A secured loan is where the borrower provides collateral (such as equity in a home or car). The lender will then typically take ownership of that security until the loan is paid in full.
Unsecured loans are those where no collateral is required. They’re granted based on credit history and other factors like income and available assets.
If you don’t have a lot of cash upfront for your purchase, an unsecured loan may be best for you. You’ll need less money up front to complete the purchase.
However, if you’re planning on buying a commercial property that’s significantly more than the median house price (in most places, this is around $200,000), an unsecured loan may not be available. Lenders will need some form of security in case they can’t repossess your building if you default on your payments.
The best option for these cases is secured loans such as mortgages or home equity loans. These often have lower interest rates than other forms of financing because there’s no risk to the lender.
Now you understand these broad categories of loans. Let’s look at specific types of property loans that fall under secured and unsecured loans.
Traditional Commercial Mortgage
A mortgage is probably the form of a property loan that you will be most familiar with. The lender will hold onto your home as collateral for up to 30 years (federal laws determine this).
Even though they are common, mortgages are complex financial products. They also require a significant amount of time and money to obtain from a lender.
Be sure to shop around before you apply for one. You’ll often find considerable differences in interest rates and fees among lenders with similar products.
Mortgages are longer-term forms of financing, which means they usually carry higher interest rates than short-term loans. This may not be an issue if your building performs well and appreciates faster than the interest rate.
One thing to watch out for is high prepayment penalties that can eat into your profits later on. You should also know what other fees are associated with the loan, such as application fees, appraisal costs, or processing fees.
SBA 7(a) Loan
Since financing for small businesses is difficult to come by, the Small Business Administration was established to offer competitive loans and other financial assistance. The agency offers a 7(a) loan program that is ideal for commercial property investors. It provides low-interest rates and long terms of up to 25 years without prepayment penalties.
To qualify, you will need a credit score of at least 680, 2 years experience in your field, and $25K in collateral.
The SBA will then work with approved lenders who have access to funding from banks and private investors. Be careful about which lender you choose because they are not all equal. You should always shop around to get the best deal possible.
The SBA can also help you with financing for various buildings, including shopping centers, office space, and hotels. They even offer a program for funding things like apartment complexes.
Adjustable Rate Mortgages (ARMs) are common in the residential property market but are frequently used by commercial real estate investors.
They function as a traditional mortgage, except they have an adjustable interest rate. The interest is lower than fixed-rate mortgages for a period of time, which may help you pay less in interest overall.
The rates will then adjust at predetermined intervals until they reach a cap.
Because your bank doesn’t have any security beyond your home, ARMs often carry higher interest rates and fees than other forms of loan financing. You’ll also need good credit and cash flow because you’re forfeiting collateral if you default on the loan.
However, if you’re a risk-taker who wants to take advantage of lower rates over the short term, an ARM loan may be for you.
Commercial Bridge Loans
Commercial bridge loans are short-term commercial real estate loans that come with high-interest rates and fees. They can be used to help you finance a recent acquisition until you can obtain a long-term loan such as an SBA 7(a) loan or a traditional mortgage.
Bridge loans are generally only appropriate if your business can pay off the debt within 12 months because of their cost. If you’re unable to do so, they would have more value in helping you take out multiple short-term loans with lower interest rates and fees instead.
Most bridge loan terms are less than one year, but some lenders offer up to 3 years (longer terms may come with higher interest rates).
If your building needs renovations or equipment before it generates income, bridge loans may be your best option.
Keep in mind that they are only meant to fill gaps and not fund any project. They can also come with much higher interest rates than traditional commercial property loans.
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Invest With the Right Types of Property Loans
Commercial property loans are abundant and come in many forms. You can use them to buy buildings as well as renovate, expand, or develop them.
The exact type of financing for commercial real estate you need will depend on your goals and needs. But they all have some things in common such as a stated value, a loan-to-cost ratio, best interest rates, prepayment penalties, and fees.
If you’re trying to decide between many property financing options, try to find one with no prepayment penalty and an interest rate at least 1% lower than the others. Your goal is to cut the nominal cost of the loan itself, the interest rate and fees.
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