Residential Vs. Commercial Loans

Author: Woodsboro Bank

Categories: Blog

Individuals who are interested in investing in real estate often turn to loans to finance their purchases. If you have access to some money but cannot cover the full price of the property you are interested in, you can borrow the amount that you need from a lending institution such as a bank. Here is a look at two basic financing options for real estate investments: residential and commercial loans.

What Is A Residential Loan?

A residential loan is a basic type of loan that many people obtain to purchase their primary residence. These types of loans are also available to investors, but they typically have to put more money down and pay a higher interest rate on a residential loan that is not used for a primary residence. In many cases, investors will need to be able to put at least 25% down on the investment property. Residential loans can be obtained for periods of as long as 30 years, although shorter terms may be an option for some borrowers. Qualifying for this type of loan depends on the borrower's finances. The bank will request documents such as tax returns, pay stubs, and other financial documents to be considered for approval.

What Is A Commercial Loan?

A commercial loan is a type of loan that can be used for rental properties. When compared to residential loans, they typically come with a higher interest rate and a shorter overall term, such as 20 years rather than 30. Commercial loans are the only choice for financing a property with five or more units, although borrowers can also choose a commercial loan for a property with fewer units or even a single-family home, if desired. For borrowers who wish to purchase a property in the name of an LLC rather than their personal name, a commercial loan has some advantages over a residential loan, such as eliminating the quitclaim process. Here is a look at some of the ways in which these loans differ.

Qualifications and Limitations

A commercial loan is a good option for borrowers who lack W-2 income or the income history needed to qualify for residential loans. Banks typically request a few years of history of W-2 income before extending a residential loan. For those who are self-employed and do not pay themselves a salary, a commercial loan may be a good option as these loans are based more on the property’s performance than the borrower's finances. The more income that an investment property generates, the less important the borrower’s personal income becomes. Another important consideration is the fact that there is a limit to the number of residential loans a single borrower may take out. Right now, this limit is set at 10 residential loans for individuals, while married couples may obtain a maximum of 20 residential loans in some circumstances.

Interest Rates

In general, residential loans tend to have a fixed interest rate across a longer term. This rate is locked in and remains the same, making it easy to predict monthly payments. Commercial loans, in contrast, typically come with a variable rate that is tied to a standard index and will go up and down with it. When combined with the shorter amortization period of these types of loans, the lender’s risks are reduced. However, it is important to note that it is possible to obtain residential loans with variable interest rates in some situations.

Source

A residential loan can be sourced from most major banks as well as national mortgage lenders. However, commercial loans typically come from local banks. This means that it is important to develop a personal relationship with a bank in your community if you intend to obtain a commercial loan.

Flexibility

A 30-year residential mortgage with a fixed rate gives borrowers a degree of flexibility when it comes to repayment that is not seen with shorter-term commercial loans. This means that, for example, if an investment property experiences high vacancy or suddenly needs an expensive repair, there will usually be more cash flow available to handle these expenses than there is for those who are making higher payments on a shorter-term commercial loan with a higher interest rate.

Reach Out to The Lending Specialists At Woodsboro Bank

There are plenty of advantages and drawbacks to both residential and commercial loans. For borrowers who do not fit into one of the specific scenarios requiring them to choose one over the other, it can be a difficult decision to make. Speaking to a professional can help shed light on the best way forward in your situation. Reach out to the experienced loan professionals at Woodsboro Bank to find out more about the services we offer and obtain guidance on the right financing product to suit your needs.