When it comes to securing financing for an investment property, you generally have two options: a residential or a commercial loan. Each is appropriate under certain circumstances, but you will need to examine your own financial situation as well as the type of property you intend to buy before you decide which of these loans is right for you. Let’s take a closer look at residential vs commercial loans and what each type entails.
What is a Residential Loan?
A residential loan is similar to a mortgage but, instead of being used for a primary residence, it is geared toward a second property that is part of an investment portfolio. Like a mortgage, terms for a residential loan are longer (typically between 15 and 30 years).
Most residential loans will require a significantly higher down payment than a basic mortgage. Whereas mortgage down payment requirements can be as little as 3% for an FHA loan, commercial loans typically require at least 25%. You will also pay a higher interest rate than you would on a mortgage, since it is considered a riskier type of loan.
Residential loans are limited to residences with between 1 and 4 dwellings. Any more, and you will need to secure a commercial loan (see below).
What is a Commercial Loan?
Commercial loans are not limited to a certain number of dwellings, but most investors choose this option for larger properties (5 or more dwellings). This is because commercial loans tend to be more expensive, with higher interest rates* and a shorter amortization period (as little as 5 years, in some cases). This shorter loan period also results in a higher monthly payment.
Like residential loans, commercial loans also require a higher down payment. This is also, typically, 25 percent, although certain lenders may agree to a lower down payment.
*Commercial loan interest rates may also be variable, unlike the fixed rates of a residential loan. This lowers the risk for lenders but creates a level of unpredictability for the borrower.
Should I Choose a Commercial or Residential Loan?
An easy way to determine what loan is right for you is to look at the size of the property you wish to buy. If it has 4 or less dwelling spaces, then a residential loan may be the best option. Longer loan terms, lower monthly payments, and lower interest rates can give you more flexibility to pay off your loan.
However, there are a couple scenarios in which a commercial loan may be better for a smaller property. If you plan on purchasing the residence under an LLC, for example, a commercial loan is a better option in the event that you decide to sell the property (via a quitclaim deed). Under a residential loan, quitclaiming property can trigger a “due on sale” clause, which means you will be responsible for paying the balance of the loan if the bank calls it in.
Your title insurance under a residential loan may also not extend to the LLC, which means it will not cover the cost to fix any issues if something is wrong with the title. Commercial loans let you put everything under the name of the LLC, so there will be no complications related to the quitclaiming or title process.
You may also choose a commercial claim if you do not meet the salary requirements necessary to secure a residential loan. Like mortgages, residential loans often require at least two years of pay stubs/W2s in addition to stellar credit and tax returns. Many individuals who cannot satisfy this particular requirement find it easier to qualify for a commercial loan, whose requirements are based more on property performance and less on individual income.
A final reason you may choose a commercial loan over a residential loan is that you have simply taken out the maximum number of residential loans. That’s right: you can only take out a certain number of residential loans before you must switch to commercial loans. For individuals, this maximum is 10 residential loans. For married couples, this number can be up to 20, provided the loans were taken out in one spouse’s name and then quitclaimed to the other spouse who purchased it in their own name.
Best Colorado Commercial Real Estate Loans
Pine Tree Financial Partners specializes in commercial real estate loans all over the state of Colorado. We pride ourselves on working with all types of investors and look forward to helping you make your dream a reality. Loans are given on a case by case scenario, so contact our office today to schedule a consultation and start your loan process.