Real estate investors buying a residential property often assume that commercial mortgage rules are similar to criteria set for residential property loans. This misconception is the root cause that leads to wrong decisions while borrowing money from a financing organisation.
Buying commercial property on loan rather than paying the total amount from pocket results in greater cash-on-cash return. Mortgage loan vs commercial loan has been explained here in detail as the mortgage rules, and list of lenders vastly differ in both cases.
Main differences between a residential and commercial mortgage loan
While analysing the structural policies established by different lenders of residential and commercial loans, one will definitely notice differences in the following aspects:
It refers to the loan window necessary to repay the loan amount in equal instalments. This amortisation period for commercial mortgage loans is considerably shorter than a typical loan term (number of years until the outstanding balance is due).
Generally, residential mortgage loans have a prolonged tenor of about 30 years; thus, it involves more uncertainty on the lender’s end. Contrarily commercial property loan on business properties generates higher monthly revenues for the financing institution and calls for more costs on the borrower’s end.
The borrower must pre-plan for this refinancing, as the total balance must be paid back within a shorter duration. He/she may either sell the property at a profit or initiate a favorable revenue stream from the acquired property.
One of the foremost factors many real estate investors check before selecting any property type is the amount of risk involved.
To many people, commercial mortgages seem slightly riskier than residential ones because the lender considers one’s debt coverage ratio instead of verifying his annual salary or income.
Ideally, the borrower has to ensure that his/her business secures at least a 1.25 debt coverage ratio, i.e., a 25% surplus over the annual mortgage payments. If the revenue remains below this margin, it becomes difficult for the proprietor to reinvest and manage his/her overall budget for the upcoming year.
For residential loans, the lender readily approves the requested loan amount if they feel the borrower’s income is sufficient to cover the mortgage amount on time. Generally, the loan amount is quickly approved when the mortgage payments are within 28% of the gross monthly income. However, lenders may also set some additional factors that one must know before applying for a loan against property.
A bank or NBFC may take up to 6 weeks to process a commercial mortgage loan application.
Compared to this, a residential mortgage request is scrutinised and approved within a shorter period (nearly 4 weeks).
To get credit sanctioned even faster, one must meet the eligibility criteria for a loan against property. However, one should not expect a processing period of fewer than 4 weeks if they buy a residential property using a mode of payment other than cash.
Amount of down payment–
Financing institutions are stricter while sanctioning the down payment for a commercial mortgage loan leaving almost no room for negotiation. Also, when getting a commercial property loan, the upfront costs for a borrower are comparatively higher in most cases. It is almost 20% of the entire mortgage sum.
A person is liable to a smaller down payment for the equity bought against a specific residential loan. Moreover, if the residential loan is amortised over a long term, for example, about 25 or 30 years, they incur much lowest interest rate loan against property.
Furthermore, a few lending institutions in India help their existing customers meet financial demands with pre-approved offers. These tailored deals on loans against property can significantly speed up the loan application process. Customers can check their pre-approved offers on financial products like commercial mortgage loans and loans against the property by entering their names and contact details.
Whether an investor finds the value of a commercial property to be rising more exponentially in the longer term or a chance of generating consistent cash flow, he/she should first develop an idea regarding mortgage loan vs commercial loan. It eventually helps in mapping out conventional sources of funding required to repay the outstanding balance within the amortisation period.