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Understanding Commercial Mortgages

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Understanding Commercial Mortgage Loans

 

What is a commercial mortgage?

 

A commercial mortgage document spells out how you must maintain the underlying collateral for a commercial real estate loan and the remedies available to the commercial lender should you default on the promissory note or fail to maintain the collateral in a satisfactory manner.

 

What is a commercial loan?

 

The term "commercial loan" is sometimes used interchangeably with "commercial mortgage," and for the sake of argument, this is acceptable.  However, the two are really quite different. A commercial loan is: monies provided by a commercial lender to the borrower, individual or corporation, in exchange for the borrower collateralizing the loan with the commercial real estate. A commercial mortgage is: the instrument that perfects the lien on the collateral, provides rules for properly maintaining the property, and the lender's remedies in the event of default on the commercial loan note.

 

How do I qualify for a commercial mortgage?

 

You don't qualify for a commercial loan! The commercial real estate is the predominant factoring in the qualification process for commercial mortgages. However, with that said, you the guarantor can either positively or negatively impact the qualification process for your commercial loan. If this is confusing, this example may help clarify:

 

The commercial real estate is the collateral for the commercial loan. Therefore, we must first look at the underlying asset as the source of repayment for the commercial loan. For example, you have a 16 unit apartment building in which you are seeking to refinance. Lenders will first look to the apartment building as a source of repayment for the loan.  The underwriter will look at the properties rent roll and P&Ls and determine the annual income and expenses for the property and simply determine if the annual cash flow can service the debt.  This is a very basic equation for quickly calculating the properties DSCR.

 

The DSCR equation looks like this:

 

Annual Income - Annual Expenses / Annual Total of Loan Payments = DSCR

Here is a bare bones quick and dirty method to determine a commercial loan's DSCR:

Annual Income ($100,000) - Annual Expenses ($12,000) = $88,000.

So, we have $88,000 in annual free cash flow to service the debt of the commercial loan or apartment loan.

 

Now we calculate the annual debt for the collateralized property:

 

Annualized Monthly P&I Payments ($65,000).  Now we can determine the first and most important step in the prequalification process for you commercial loan or apartment loan.

 

Annual Income - Annual Expenses ($88,000) / Annual Total of Loan Payments ($65,000) = DSCR (1.35)

 

A DSCR of 1.35 means the annual cash flow from the property can cover annual debt from the property 1.35 times. This is a good DSCR. Most lenders underwrite most commercial loan requests or apartment loan requests at a minimum qualifying DSCR of 1.25 times.

 

If the minimum DSCR is met, the lender will next look at the guarantor and determine eligibility.

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