The Abcs of Real Estate Financing

Real estate financing is a commercial loan typically offered to finance the purchase of buildings or land for a business. The property is often used as collateral and the lender will have a legal claim over it until the loan is paid off.
Obtaining real estate financing is not quite as easy as getting a home mortgage loan. Typically, it will require substantial collateral, good business credit/strong financial history for your business, and lots of paperwork.

There are two aspects of real estate financing that are key to selecting a commercial mortgage loan that best suits your needs: interest rates and repayment schedules

Interest Rates
Real estate financing is offered with one of two interest rate options: Fixed rate or Variable rate commercial mortgages

*Fixed Rate
With a fixed rate, the interest charged on the principal will remain the same throughout the term of the loan. The interest rate is determined based on the current market rates as well as the risk involved in financing the project.
The advantage of this option is that your interest rate remains fixed and predictable. The downside is that if market rates go down, you are still stuck with the same rate.

*Variable Rate
With a variable rate, the interest rate charged on the outstanding principal will fluctuate over the life of the loan, based on changes in market rates. This interest rate is calculated by adding a predetermined premium to the current market rate. This premium remains fixed over the life of the loan, while the market rate fluctuates.
A key advantage of the variable rate financing is that your initial interest rate will generally be lower than you would on a fixed rate. It also enables you to save money when market rates fall. The main disadvantage is that you have no protection from an increase in the market rates.

Repayment schedules
There are three main ways that real estate financing is structured to determine your repayment terms.

*Equal Loan Payments
This is the most common repayment schedule, and is typical of a fixed rate mortgage loan. The monthly loan payments are of the same amount over the life of the loan.

*Equal Loan Payments with a Final Balloon Payment
The monthly loan payments also remain the same, on this schedule, for a relatively short period of time. However at the end of the loan term, the balance of principal and interest must be paid in one single payment, called a balloon payment. At this time, you often have the option of refinancing to pay off the often-hefty balloon payments.
This type of loan has the advantage of lower payments during the loan terms, leaving you more cash flow for your immediate business needs. There is, however, the huge balloon payment awaits at the end of the loan term.

*Interest-Only Loan Payments with a Final Balloon Payment:
With this payment schedule, your monthly payments are applied toward the interest charged on your loan, while the principle remains the same. At the end of the losan term, you will have to pay a balloon payment that includes the entire principal, as well as any remaining interest.
The main advantage of this repayment schedule is lower monthly loan payments. On the flip side, however, you will end up paying a lot more in interest because the principal amount on which the interest is paid is not reduced.

What is the usual length of a mortgage?
Mortgages loans offered by real estate financiers are typically for terms of 5 to 25 years. For newer properties, the maximum length is generally 20 years, and for older properties, it is 15 years.

How much of a down-payment should you make?
The larger your down-payment, the more secure (less risky) the mortgage loan is viewed to be, and the lower the interest rate you will be able to negotiate. A down-payment that is 20% to 30% of the property purchase price is standard in the industry. However, you may get real estate financing with a down-payment as low as 5% if you have a strong business history and credit rating.

How can your improve the chances of getting real estate financing?
Have a solid business plan that demonstrates that your project will succeed and you are sure to repay the loan. Although the financed property serves as collateral, the lender’s decision will still be base on your ability to repay the mortgage loan.