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What is the Difference between Funding a Residential and Commercial Property?

Residential home loans and commercial mortgages are loans taken for the purpose of property and the both use the property as collateral itself. So, what’s the difference between both of them? Financing for commercial property is entirely different from financing the residential property as there are different lenders and they have different criteria. Before stating the difference between commercial and residential financing, you must know the meaning of these terms.

Commercial Financing

Commercial financing is a debt-funding arrangement between a business and a financial institution (lender), typically used to fund major capital expenditures or cover operational costs that the business may otherwise be unable to afford. This is type of loan is secured by the commercial property, like office building, apartment complex, shopping center or individual house.  

Residential Financing

Residential financing is a type of loan that people take in order to buy a residential property. This type of loan is secured by a lien on the property and the borrowers repay it over a specified period of time.

The Difference Between the Two

Difference of funding a residential and commercial property is listed below:

  • The Interest Rates

The interest rates of commercial property loan are generally higher than residential property loans for the simple reason that, there is a greater risk of default on commercial property from the lender’s point of view.

  • Collateral or Security Requirement

Some lenders have lower rates because they allow cross collateralize of borrowers home as well as their primary commercial property. Hence, by using additional collateral a lower rate can be accomplished by reducing the LVR (loan-to-valuation ratio). Having a lease on the property is critical in obtaining an economical loan rate. Costs and difficulty in finding funds largely increases if the space is vacant.

  • Loan to Value Ratio Range

Lenders require that the borrowers pay a larger down payment while purchasing a commercial property. Lenders generally finance 75% on mixed use, multi-family and retail types of property.

It is quite common to see that bank and non-bank lenders issue loans up to 90% of the property value. Loans for the commercial property are more conservative where the limit for the LVR usually tapers out after 70%.

  • Loan Terms

Residential mortgages can be 25 or 30 years, where commercial mortgage loans are much shorter, typically a span of 3 or 5 years where the bank will decide and review the lending facility or agreement.

  • Upfront Costs

Due to involvement of various parties, there are more upfront costs as compared to residential mortgages. This includes legal fees on the loan, valuation fees for a valuation bank would require as part of the financing process, stamp duty on the loan or the mortgage as well as larger sites building report.

  • Ongoing Costs

The fees of a commercial loan are much greater than residential mortgage, as this carry a very small amount. In some products, there are likely additional ongoing costs, like account fees, line fees and draw down fees. This fee does not have be material, though, it also something that you might be aware of.

  • Payment Structure

The interest on the commercial property is repaid with every payment and there are no offset accounts. Renovating a commercial property is relatively expensive as compared to renovating a residential property.

Final Words

Obtaining commercial fund for your property is very much different from obtaining a residential property fund. A major difference between commercial and residential property loan is the method of financing. Thousands of residential mortgage lenders compete with each other on the basis of finance.