What’s the difference between Commercial and Residential?
Commercial loans differ from residential loans in several key ways. Although they do look at the same standards as residential loans, they look at them from a slightly different angle. Here are few things you should know prior to applying for your loan:
Borrower vs Property Debt to Income:
Obviously, debt and income is still important as a factor for lending, as it shows what kind of financial person you are. However, when dealing with multi-million dollar loan amounts, a person’s personal income becomes much less important because, frankly, if things went south, a borrowers job income is not going to be able to make the payment, regardless. This is why SpotOn Financial will look at commercial property with a different view. Our decision is based much higher on two things:
- 1. The ability for the property to provide cash flow.
- 2. The investors experience and ability to manage the business or property.
These two characteristics of the deal are much more important in decision-making for the deal than the official “debt to income.” This is why it is so important to obtain the best deal possible when looking for investment property. When you are applying for a commercial loan, it’s also important that you properly convey yourself as the business owner that you are – not some hobbyist. We suggest a borrower have a business plan prepared, know the answers to the questions we will ask, and know the deal inside and out. Consider a property investment loan request the same as a job interview – and come prepared. Understand clearly the value proposition for you the investor, and us the lender.
Credit score is still highly important for commercial lenders, because it conveys your ability to handle money and credit well. Although the rates differ, we typically want to see at least 680 or higher for a credit score.
Loan to Value
Loan to value is much more valued in commercial real estate lending than residential. As mentioned earlier, we prefer our borrowers are not over-leveraged and they have significant equity in the deal. Typically, a we will want a minimum of 70% loan to value (LTV) on a deal so we have 30% equity in case we need to foreclose and re-sell the property.
Debt Service Coverage Ratio
Exclusive to commercial investing, the debt service coverage ratio, or DSCR, is a ratio used to look at the properties ability to generate cash flow. Essentially, the DSCR compares the total income that comes in (not including the mortgage payment) with the payment on all debts. Here is the simple formula
DSCR = (Net Operating Income) / (Debt Service)
For example, if a property’s Net Operating Income (the total income left to pay the mortgage) is $10,000 per year and the total debt payment is $10,000 per year – the DSCR would be “1.” Typically, a commercial lender wants to see a DSCR of at least 1.2 – meaning that after all the expenses are paid, there is at least 20% cash flow profit on top. Keep in mind -this is a very basic explanation of the Debt Service Coverage Ratio. The purpose of the example is to provide a basic understanding prior to you applying. The more you know the greater chance you are approved.
As mentioned earlier, a approach your loan request like a job interview. You are asking SpotOn Financial to fund your next deal. Like a job interview, experience is key to success. Experience as a landlord is not always a requirement, but it definitely helps your case as a good bet for approval on the loan request.
SpotOn Financial will consider all commercial cash flowing properties. We look for the bank quality properties (multi-family, office, retail, and mixed use) we also like gas stations, C-stores, single purpose, church or religious properties, auto repair, and car dealerships.