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Most real estate investors, especially when just starting out, use personal credit to obtain conventional loans to buy rental homes. And this may work fine for you today, but how serious do you intend to get about your investing tomorrow? But if you plan to increase your portfolio or add larger buildings, you graduate out of conventional loans. Portfolios with more than 10 rentals or buildings with five or more units require a separate LLC and a commercial loan. With today’s long-term financial financing options, investors can take advantage of 30-year fixed mortgages on commercial loans now, too. And they apply to single-family rental units. Just like conventional loans, commercial loans rates vary from investor to investor. Below we list seven factors that determine your commercial loan rates and terms.
1. Credit Score
When you apply for a personal loan, the higher your credit score, the more breaks you qualify for on rates. The same works for commercial loans. Over certain milestones (i.e., 680, 700, 720. 740, and 780) rates become increasingly better. You look less risky to banks who are willing to accept lower interest rates for higher quality applicants.
2. Loan-to-Value Ratio
This may seem like common sense, but the lower the loan-to-value ratio for the property, the more attractive the deal for banks. Although residential loans may qualify for up to 100% of the value of the property, commercial rates start at 75% or less. And banks will offer additional breaks when loan requests come in at varying percentages of the value of the property.
3. Loan Size
Believe it or not, the larger the size of a commercial loan, the better the rates banks will offer. Why? Because right now banks have a sizable amount of capital they need to pour into the economy. With so much liquidity, larger loans look like attractive ways to do this and will offer pricing breaks.
4. Prepayment Penalty Duration
Sometimes called yield maintenance, prepayment penalties cover a portion of the expected cash flow if loans are paid off early. Most conventional loans do not have prepayment penalties, but nearly every commercial loan will.The longer the duration of the penalty period (usually five years or less), the lower the rates offered. This is because banks have greater security on expected cash flow by discouraging buy-and-flips.
5. Loan Type
Expanded loan options now allow investors to take out 30-year fixed mortgages for long-term loan stability. However, those who plan to flip or refi after a few years can see better immediate rates for 5, 7, or 10-year ARMs. ARMs can offer lower rates that may make sense for someone planning to sell property within a few years. The 30-year rate can help others avoid the need to refinance every few years, hoping interest rates remain favorable.
6. Cash Out Vs Straight Refinance
Whether an applicant wants to get cash out of a mortgage refinance has a big impact on rates. Applicants who only want to refinance existing mortgages for better rates and terms will get lower rates. Anyone who wants to also get cash out - whether for improvements or capital to buy another rental - will pay more. Why? Banks want to know the likelihood of recouping costs if they need to repossess and sell a property.
7. Debt Coverage Ratio
When applying for a personal loan, banks look at a person’s debt-to-income ratio. Banks consider operating income for commercial loans to determine how well the property cash flows. They subtract all property expenses from rent to get the operating income. Expenses for a rental property include: mortgage, taxes, insurance, vacancy, age and last renovation, annual maintenance, and property management fees. Anything under 1.0 loses money, but anything 1.2 or greater receives better breaks.
As you can probably tell, you can’t just march into a commercial loan lending business demanding to know their rates. The answer requires thorough consideration of many factors, including these above. Need advice on your next investment property or where to go for commercial lending options? Call the experts in Chicagoland investment property.
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