Commercial property is an income-producing property and is used only for business purposes, such as mixed-use properties, fix and flip properties, schools, hospitals, offices, shopping malls, and others. People purchase commercial real estate either to establish a new business or to develop and diversify an existing one. Financing this kind of property, including acquisition, construction, and development, is usually accomplished by taking out a commercial loan.
How to get a commercial loan?
Just like home loans, banks and private lenders offer loans on commercial properties. Lenders usually require the property to be owner-occupied, meaning that the borrower’s business must occupy at least 51% of the property. If you are planning to get a commercial loan on your property, examine the type of loan you need first. Depending on the property and business, narrow down your options to choose a lender.
What do lenders consider while making a commercial loan to the borrower?
Lender typically look for four things before granting a commercial loan. These four sets of requirements are your business finances, company’s credit, personal information, and the characteristics of the property on which you are taking out a loan.
Let’s have a closer look at these requirements:
- Business finances – Lenders consider smaller businesses risky, so they require a lot of go through a detailed underwriting process that asseses risks and profits. They look over your business finances to verify that your business produces enough income to repay the loan. The lender will also evaluate your business’s debt service coverage ratio. This ratio is the result obtained by dividing your net operating income (NOI) by your annual total debt service. Lenders typically require a ratio of 1.25 or more.
- Company’s credit – Your company’s credit plays a vital role in getting a commercial loan. This is one of the determining factors that affect the loan term, such as interest rate, repayment period, required down payment, etc.
- Personal finances – Behind every company is a person or group of people. Particularly when a business is new or does not document significant earnings, the owners of the company’s finances are reviewed carefully. Small businesses are generally operated by an owner or a few business partners. Banks and private lenders will want to scrutinize your personal credit history to make sure that you have never faced financial problems such as defaults, foreclosures, tax liens, court judgments, and more. A low credit score will lower an individual’s chances of qualifying for a business loan.
- Property characteristics – The property against which the borrower is taking out a commercial loan serves as collateral. That is why the lender attaches a lien to that property to secure it against the loan. If the business defaults on the loan, the lender has the right to seize and take over the property. The borrower must occupy at least 51% of the property for getting approved for a commercial loan.
These are the main things that lenders consider when making a commercial loan. They review all these factors just to make sure whether the borrower is capable enough to repay the loan or not.
Where to get a commercial loan?
If you are wondering whom to approach to get a commercial loan, there are multiple financing sources that you can reach out to, including:
- Banks – Banks offer commercial loans on various types of properties, and the typical amount is about $1 million. The major advantage of taking out a commercial loan from a bank is the reasonable interest rate they offer. If you are an existing bank customer, you can get a good possible discount too. Banks offer long-term financing options that entice borrowers. If you look at the negative side, banks require a lot of documents and take a lot of time to approve your loan application. Only borrowers with excellent credit history or scores are eligible to get a commercial loan from the banks.
- Commercial lenders – Numerous private finance companies offer commercial loans to small and medium-sized businesses. If you do not want to be stuck with the slow process of banks, a commercial lender would be a feasible option. Although rates are comparatively higher if you need a loan fast, approaching a commercial lender will be in your favor. The underwriting standards are flexible, and the fees and other costs are lower with commercial lenders. However, lenders may require a balloon payment in 5-10 years.
- SBA 504 loans – The long-term loan programs are specifically designed for financing real estate projects and long-term equipment. When you take out an SBA 504 loan, you are required to put in at least a 10% down payment, which is comparatively low. The interest rate is typically lower than the existing market rate, and the repayment term is 20 to 25 years. If you want to qualify for this loan, you must meet SBA size standards. However, the loan approval and funding process is slow, you can save more on interest as it is comparatively low.
- SBA 7(a) loans – This commercial loan allows businesses to borrow the loan amount of up to $5 million. The borrower can use this loan amount for construction, development, purchase, or renovation of the property. This is a long-term loan, with terms of up to 25 years, and the borrower can take advantage of competitive interest rates. Note that the borrower must occupy 51% of the building for expanding an existing business and 60% property must be occupied by the owner for new construction.
- Hard money lenders – Hard money lenders offer loans that are specifically designed for real estate investors. These loans are short-term in nature and backed by real estate assets. Qualifying for a hard money loan is easier, and it requires fewer documents. However, the interest rate and down payment are comparatively higher. But if you are looking for fast funding, this is the best option that you can choose. The borrower’s credit score does not matter much here because the loan is secured by the value of the property that the borrower has put up as collateral.
As you can see, there are various financing sources available. Shopping around and comparing the interest rates and loan terms of each source will help you choose the best one that fits your needs.
What do you need to apply for a commercial loan?
Applying for a commercial loan often requires a myriad of documents and is a slow process as well. The only option that can help you get the fastest commercial loan without submitting a lot of documents is a hard money lender.
Generally, banks and lenders require you to share the following information:
- Business tax return
- Details of the property
- Bank statements of at least 3 months
- Business plan
- Individual’s and company’s financial report
- A third-party appraisal of the property
If you choose a hard money lender as a source of funding, they won’t require this much information. They focus mainly on the equity of the property and not on the borrower’s credit history.
Process of getting a commercial loan
The application process varies depending upon the financing source you choose. However, the typical process to get a commercial loan is as follows:
- Pre-qualify: The lender or bank will begin the loan application process by evaluating the financial history and current income produced by the business. Apart from that, the lender will also investigate the purpose of the loan and whether the business already has existing debt. The pre-approval process determines how much of a loan amount can be given to the business or how much the business will be able to pay. The overall pre-qualification process gives a rough idea of the level of risk associated with the lending amount.
- Loan application – Once you pre-qualify for the commercial loan, your company will have to submit a formal loan application form. A company’s financial statements for at least 3 years or some similar documents are generally required with the submission of the loan application form. Lenders require these documents to make sure that the business can repay the loan within a specified period.
- Review of application form – Once you apply, a loan officer will review all the documents. They will examine your credit history, collateral, the current and projected income of your business, etc. The most crucial part of this due diligence is the financial analysis.
- Loan committee – If the loan officer finds everything appropriate after investigation, he submits a formal credit application to either an adjudicator or loan committee for further review. Now the adjudicator will examine all the relevant information and decide whether to approve the loan or reject the loan request. This process may take up to 7 days, and during the review process, businesses may have to provide some additional information if required.
- Term sheet – If your loan application is approved, your company will receive a term sheet. It is a formal document that contains all the information about the loan, such as the involved parties, collateral, amounts to be funded, use of the loan, charged interest rate, and everything. Give a thorough review of the term sheet. If you agree to the information provided in the term sheet, you will have to sign a letter of intent.
- Loan closing – Once you complete the third-party report, the loan application, along with all the relevant documents, is resubmitted to the loan committee for final approval. If the loan committee finally approves your complete loan package, the business has to sign the finalized loan documents. In general, businesses hire a closing agent who handles all the paperwork.
Once the lender closes your loan, you will get the funds within the specified time. Note that only hard money lenders will help you get the funds fast within days, otherwise most financial institutions take a lot of time and require a lot of documents. So if you need funding fast, choose a hard money lender. Otherwise, any of the financial institutions mentioned above can provide you with a loan if they find you eligible.