Q: Why would you need a commercial loan when you are purchasing a residential income property? It just doesn’t seem to make sense.
A: Because the underwriting guidelines say that any residential property with 5 or more living units will require a commercial loan. That’s why.
Take this 5 unit apartment pictured to the left here. Because it is over 4 residential units underwriting guidelines will not allow a residential mortgage. That goes for any investment property 5 units and above.
You may now be asking yourself what are the main differences between a “regular” mortgage and a commercial loan. Well, I’m not going to hit every point but I’m going to highlight some of the biggies.
- Residential investment property loans may allow you to put only 5%, 10% or 15% down. It is very unusual for that to happen with a commercial loan. In fact, 20% is almost a mandatory minimum with 25% being even better.
- You can decide how profitable a residential mortgage purchase needs to be but if a bank is getting involved with a commercial loan they are looking more at the qualifications of the apartment being purchased than they are looking at you. The commercial banks have minimum standards for what cap rates should be for commercial loans they are underwriting.
- Regular mortgage loans can be amortized over 15, 20 or 30 years. Commercial loans are almost always a 20 year am, maximum. Although I have seen a movement towards 25 years on some more expensive apartment complexes.
- Your closing costs will be exponentially higher. Points are usually higher. Appraisals will definitely be higher.
- Experience matters when qualifying for a commercial loan.
Right off the top you can see that you had better not be considering any residential income property that has more than 4 units until you have the cash, credit, experience and banker to do so.
That’s another great reason to begin your real estate investing career with easily manageable, easily affordable single family homes, duplexes and fourplexes. After you’ve been through a 1031 exchange cycle, or two, then you’ll have the cash available to go after the commercial properties.
Fun Fact: I’ve got a 26 year old right now who owns 7 investment properties. He’s on the fast track towards being a multi-millionaire who owns commercial properties by the time he’s 40-42 years old. Now that’s a way to build a retirement worth having.