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Commercial Real Estate: Mortgage Types
by Amy Lillard
Jun 20, 2007 - If you're ready to make the leap to commercial real estate, you're poised to make great money. That is, if you know what you're doing. In our continuing series, we examine the basics of buying commercial real estate, along with tips for the process.
Commercial real estate mortgages are a bit more complex than residential mortgages. While they share many similarities, commercial mortgages are harder to obtain and often tied to both your personal and business success. Common commercial loans include:
- Amortized Mortgages: Just like with residential mortgages, commercial loans require you to make amortized payments. This means you pay an equal amount each month over the term. At first, the majority of your payment is interest. As months pass, you pay more and more towards the principal, until eventually the loan is paid off. Fixed-Rate mortgages have an unchanging interest rate for the entire loan term. Variable (or adjustable) rate mortgages offer lower initial interest rates. With each month, your interest payments will vary according to market conditions. These are riskier as mortgage payments may vary month to month. Many commercial lenders begin with fixed rates for up to five years, then switch to variable rates for the rest of the term.
- Interest-only mortgage: The common confusion with this popular residential and commercial mortgage is the role of the principal. Your payments for the first few years are, in fact, interest-only, resulting in lower payments. But, when the interest-only period ends, your principal still remains. And now you have less time to pay it off, resulting in bigger payments.
- Mortgages with balloon payments: This type of mortgage is unique to commercial loans. This is a shorter-term loan ranging from 5-15 years, requiring small monthly payments that include interest and principal. After the term, you will be required to make a “balloon payment,” consisting of the remaining interest and principal. The danger here, of course, is a very large bill that comes due.
- Other mortgages: Depending on your financial situation and goals, you may qualify for other less common commercial mortgages. Endowment mortgages are similar to interest-only loans, but paid with money from life insurance policies, personal savings accounts, and retirement plans. Hard money or bridge loans are short-term financing with less documentation and higher interest rates.
Just as with residential loans, many fees are charged before the loan even begins. These up-front fees can add up very quickly into the tens or hundreds of thousands. These fees include:
- Valuation fee. Part of the loan approval process includes appraisal, which can cost up to $4,500 depending on the size of the property. If you're buying a land plot to build on, these fees may be more.
- Environmental surveys. More stringent inspections are required for certain properties that represent potential danger. Inspections can vary from $1,500 to $10,000.
- Due diligence. As part of the loan approval process, the lender will run several credit and background checks to check your credit and ability to pay. This can cost several hundred to a few thousand dollars depending on the time and work involved.
- Broker fees. Brokers usually charge one-half to two percent of the loan value for his or her services.
- Legal costs. A lawyer should always review the contract, check for hidden charges, and ensure that the inspection work was done properly. This can cost up to several thousands of dollars.
- Additional fees. Up-front charges such as application fees ($300 to $500) and processing fees ($500 to $2,000) may be charged.
Continue reading our commercial real estate series to learn about commercial mortgage in's and out's, and the process for obtaining a commercial mortgage.