The differences between residential and commercial lending warrant close attention.
Market competition impacts costs
With residential lending, there is a lot of competition in the marketplace and so lenders make their loan products more attractive than other lenders’ products.
Compared to commercial loans, residential loans have lower interest rates, and there are cheaper upfront fees and more options, like redraw and repayment holidays.
With commercial loans, however, the interest rates are higher – sometimes significantly – there are much higher upfront fees and ongoing fees related to loan reviews, which are required by lenders as part of their risk management and mitigation, and the loan to value ratios are much lower, which means borrowers have to come up with significant deposits.
From the lenders’ perspective, commercial lending exposes them to a far greater level of risk, which involves a variety of additional costs to be funded and obligations that must be met.
The differences between commercial and residential lending
Generally, commercial property borrowers can expect lenders to fund up to around 75% of the value of the property – but as little as around 65%, or less.
Some major lenders will only approve commercial loans over a maximum 15 years. This is based on the ‘usable life’ of a commercial property – this compares to 30 years for residential loans.
To illustrate the difference, let’s look at a commercial property valued at $800,000. You would require about 25% deposit – that’s $200,000 – as well as fees and charges of approximately 5% – about $40,000 – and other charges, such as the cost of a valuation and the application fee – that’s about another $2000. All up, you could be looking at around $250,000 to fund the purchase.
The $600,000 that you borrow from your lender then needs to be repaid over 15 years, requiring payments of about $5770 per month.
Commercial property lenders will consider five years interest-only, but the maximum loan term is 15 years with the major lenders.
There are some niche players that will consider loan terms of 25 years whereby the loan is very much ‘set and forget’, meaning there is no need to conduct regular reviews and there are no ongoing fees. The major lenders, however, conduct annual reviews, which include a review of borrowers’ business financials.
Unique risks in commercial areas
Unlike residential property, commercial property is particularly vulnerable to changing economics, infrastructure and even consumer behaviour, and this must be factored into your investment plan.
Lenders also need to look closely at the risk associated with niche sites, as opposed to retail shop-fronts for example.
Add to that a higher interest rate and a loan term of around 15 years – or whatever you have negotiated with the lender – as well as the requirement by some lenders for regular reviews of commercial property borrowers’ financials, and you can see the risk factors, costs and commitment required to fund a commercial property investment are very different compared to residential.
If you’re considering investing in commercial property, it’s critical to work with a Smartline mortgage broker with experience in commercial lending to tailor a solution.
As with any property investment decision, if you’ve done your research and you have worked with a Smartline mortgage broker, then you can reap the rewards.