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Borrower Beware: Eight Questions to Ask When Obtaining a Commercial Mortgage

Unlike borrowing against your home, financing a commercial property can be a confusing and frustrating experience. Borrowers are often subject to unwieldy demands and requirements imposed by traditional lenders, such as banks, since these lenders are regulated and generally averse to risk-taking.

Similar to other financial products and services like credit cards or insurance, many options exist for commercial real estate buyers and owners to choose from. Consumers should take the time to understand all of the elements of a lender's mortgage program instead of simply focusing on interest rate. Becoming well informed can save a borrower time and money during the loan origination process and in the future.

Having worked with thousands of small business owners and property investors over the years, we've studied how different types of lenders operate and how they affect borrowers and their ability to secure loans.

Here is a list of eight important questions every prospective borrower should ask before selecting a commercial mortgage

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1. What is the maximum amount I can borrow?

You should first ask yourself: what are my capital needs both now and in the future? The majority of borrowers would actually prefer to pay a slightly higher interest rate in order to maximize the amount of money they can borrow. More cash on hand means more capital to invest in your business or additional real estate.

Typically, commercial lenders will loan up to 75 to 80 percent of the property value, requiring the borrower to come up with a 20 to 25 percent down payment. On a $500,000 property -- that totals as much as $125,000 down. However, programs do exist that allow you to borrow in excess of 80 percent of the property value. If maximizing cash is your primary goal, then paying a higher monthly payment may be a small price for the added capital a higher loan-to-value (LTV) ratio provides.

Additionally, you should also ask your lender if their program allows you to take out a 2nd lien mortgage, either at closing or in the future. Choosing a lender that allows 2nd liens will add flexibility in meeting your future capital needs, and will allow you to capitalize on your property appreciation without a costly refinance.

2. Is there a balloon payment?

While balloons may be a useful option for residential borrowers looking to lower their rate, it is a requirement of most commercial programs for customers to pay off their mortgage early, generally in 3 to 10 years. A balloon loan will force you to go through the entire loan process again before the balloon date. This means spending thousands of dollars in closing costs, and risking a higher cost loan if interest rates have risen. Even worse, if you are in the midst of difficult times in your business or have vacancies in your property, you run the risk of not qualifying for a loan renewal with your lender. Therefore, programs that do not require balloons are superior to those that do.

3. How soon will I have a solid commitment, and how soon can I close?
If you are shopping for a property and need to be pre-
qualified for financing, or if you are looking to close quickly, make sure you get a clear picture of your lender's timeframes. Unlike residential mortgages, traditional commercial lenders often must review your historical income statements, asset statements and other documentation before giving you the thumbs up on your loan application. It can take weeks before you learn whether or not the lender wants to take you on as a customer. And then, even after your loan is approved, you still run the risk of being turned down by a bank's "credit committee."

This bureaucratic process results in quite a bit of stress, uncertainty, misinformation and delays that may ultimately cost you a final loan approval. Make sure your lender provides you with clear and accurate information on approval and closing timeframes.

4. Will I have to maintain minimum assets or deposits?
If you are looking to a bank for your commercial loan, ask your loan officer if you will be required to hold a minimum level of deposits at the bank in order to qualify for the loan. Deposit requirements can tie up funds and be a hindrance if you need future access to that cash.

5. What are the documentation requirements?
As many traditional lenders sometimes require endless amounts of documentation, it is important to ask upfront about the amount and the types of financial documents that are required. Locating and providing copies of leases, operating statements, tax returns, asset statements and other financial documents can be quite challenging and time consuming. Furthermore, many small businesses do not have the level of documentation necessary to support their income in order to qualify for a bank loan. Such businesses are usually best served by alternative lenders.

6. How much financial reporting is required, and what financial covenants must I make?
Beware. When obtaining a commercial loan, many borrowers are not fully aware of all the future obligations imposed by the lender, beyond simply making the monthly payment. First, many lenders will require you to provide quarterly or semi-
annual financial and operating statements on your business or property for as long as you are in your loan.

While continuing to provide these documents can be more than just a simple nuisance for small businesses, even scarier is the imposition of financial "covenants," which are guarantees you must make in the loan agreement about the continued financial strength of your business. If you don't think this is important, consider the fact that certain covenants could put you in default on your loan if you lose a tenant or experience a tough business period, even if you are current on your monthly payments!

Be certain to ask your lender about reporting requirements and financial covenants. If the risk is not acceptable to you, find another lender.

7. Is the loan assumable?
Unlike residential mortgages, it is standard for commercial mortgages to charge prepayment penalties for early repayment of a loan. If you think there is a chance you may be selling the property at some point in the future, ask your lender if the loan is assumable by your property buyer. Assumable loans allow a buyer to take over the mortgage terms and loan payments. It is also an excellent selling point that can enhance the marketability of your property when you list it for sale.

8. What are the total costs associated with getting the loan?
A little research upfront about the costs associated with the loan can potentially save you thousands of dollars. Be sure to ask about all costs you will be responsible for, including lender fees and points, property survey, environmental reports, and any legal fees that might be associated with the loan. Some lenders will have less expensive alternatives, or will bear these costs altogether.

When shopping for a commercial mortgage loan, remember that there are vast differences between lender programs. Different loan programs should not simply be compared based on the interest rate. It is also important to remember that banks are not the only lending institutions out there. Many alternative lending solutions, such as Commercial Direct®, provide customers with a simplified and flexible lending process, without the distraction of a bank's rigorous requirements. Asking the questions outlined above can save you time, money, and a big headache down the road.  

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Brett Evenson is Managing Director of Commercial Direct ®, a division of Bayview Financial Small Business Funding L.L.C.
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