Differences Between Residential And Commercial Loans

By: Eric Morgan

When you go to apply for a loan, you will find that there is a rather large difference between a residential and a commercial loan. This means that you will need to understand the differences in advance so that being unprepared does not hinder the application and approval process. You also will be sure to get a better deal when you understand more about the process and information needed to complete either one. Here is a brief explanation showing the difference between a commercial and a residential loan.

The Application Process

The process of application will vary in most of the details - as well as in the terms of the loan. A residential loan is based almost entirely on the finances of the person getting the loan. A commercial loan, on the other hand, depends on the profitability of the property at the time the loan is taken out.

&bullResidential Loan

A residential loan is designed for a building for one to four family units. For a building that houses more residents than that, you will need to get a commercial loan.

Residential loans require that the borrower provide the lender with personal financial information. Generally, this will require tax returns for the previous two years, pay stubs from your place of employment, and at least three month's worth of your bank statements.

A form 1003 (Universal Residential Loan Application) will also need to be completed and filed. This form is applicable in most states, but some additions will need to be added in some locations.

Near the end of this form, a lender is required to add a section (may be in an attachment) if you are applying for a balloon loan. It includes notice that you have opportunity to refinance, with a guarantee to do so, but it is conditional upon your being able to meet the qualifications at the time of your new application. Otherwise, you must be ready to pay the loan in full, when required.

Your financial information will also be checked. This means that your credit score will be examined, and your debt to income ratio is going to be scrutinized.

Your application will then be forwarded to the lender for their approval. Other documents will then be ordered and need to be completed before the loan can be approved. This will include papers like property appraisals, title search and escrow, and flood certification. Also, a lock on the loan will need to be included (if appropriate).

Lender's Role

Once all the paperwork is in the lender's hands, then he or she will review the paperwork. The 1003, and your credit, will be checked and verified. Other information that you have included will also be verified. Various conditions will need to be cleared, and once that is done, the final documents are drawn up and a closing date is set.

&bullCommercial Loan

The application process for a commercial loan is much different than that of a residential loan. The main difference is that a commercial loan is not at all based on your income - and for this reason the details of your personal finances are not the basis of determining whether the loan is approved or not.

Application Process

The process starts out by obtaining the financial situation of the commercial building itself. This means that the documents showing income and expenses of the property for the last two years will need to be collected. Another main consideration will be the current amount of rent being collected every month. This will become the basis of how much of a loan that can be obtained.

The broker then takes this information and analyzes it in order to make overall statements that he or she will submit to the lender. These statements include a net cash flow (NCF), loan to value (LTF), and a debt service coverage ratio (DSCR).

The main consideration here is that there is a sufficient income (at the present time), to be able to provide the commercial property with a profit from day one. Lenders will look to make sure that there is at least a 1:1.1 to 1:1.25 ratio of the monthly payment to the amount of profit that is brought in after all other expenses. Some lenders may even want a slightly higher ratio before a loan will be given.

The Lender's Role

Once the lender receives the paperwork from the broker, then he or she will review all the documents. A quote will then be sent to the borrower based on this data.

Various services will also be ordered to make sure that the property is a good investment on the lender's part. An appraisal will be required, a title search, and a credit check will be necessary. Under some circumstances, engineering and an environmental verification will also need to be preformed.

Once everything comes back, and is evaluated, then the new terms on the loan are issued and a closing date is set. The buyer then looks over the terms, makes sure they are acceptable - and gets ready for the big day.

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