The Top 3 Differences Between Residential and Commercial Mortgages

Before you apply for a mortgage loan for your Chicago investment property, you should know what your options are. The two basic types of mortgage loans are residential and commercial. It’s easy to figure out that if you’re applying for a mortgage for your business, you should be applying for a commercial mortgage. On the other hand, if the mortgage is for your home, it will be a residential mortgage. But there are some other distinctions you should know about. Here are three key differences that make commercial loans and residential loans different.

1. Property Type

The property type determines the type of mortgage that a property qualifies for; however, there are many variations to each type of mortgage. Generally, a residential apartment building with 5 units or more will be financed with a commercial mortgage. Commercial property, like a strip mall or office building will also be financed with a commercial mortgage.

2. Amount of Risk

The primary thing that separates these two mortgages is the amount of risk involved with both. Commercial mortgages are generally considered riskier than residential mortgages. This is because with a residential mortgage, lenders primarily want to know about your income to ensure you’ll have enough money to make your payments. You obviously need to be making more money than you owe. Your mortgage payments can only be twenty-eight percent of your gross income at the most.

But with a commercial mortgage, you’ll use the income from your investment property to pay back the loan. Thus, instead of knowing your annual salary, the lender has to predict whether or not your business will succeed. Obviously, this is not always easy to do, which makes it the riskier mortgage option. It is possible for your commercial property to make exactly the same amount of money in one year that you need to make your mortgage payment. In this scenario, the debt coverage ratio is exactly one to one. Generally, the preferable debt coverage ratio is 1.25, meaning that you are earning twenty-five percent more than your mortgage payments on a property.

3. Size of Down Payment

The amount of risk involved with your mortgage loan affects repayment in multiple ways. For instance, you can generally negotiate with a lender about the size of a down payment for a residential mortgage, while a lender will be stricter about a down payment for a commercial mortgage. The down payment will also be higher—usually about twenty percent—for a commercial mortgage compared to a residential mortgage. In rare occasions, lenders allow buyers to pay just a ten percent down payment.

4. Time for Repayment

The lower amount of risk associated with residential mortgages increases repayment flexibility. Repayment can be as short as fifteen years or as long as fifty. Although you can sometimes negotiate repayment with a commercial loan, usually you won’t have as long to pay it back. Ten years is the most common term for repayment. With a residential mortgage, you can usually make your mortgage payments in advance if you want. With commercial, you will sometimes face penalties if you try to make your mortgage payments for your investment property too soon.

Whether you’re searching for a residential mortgage or a commercial mortgage for your investment property in Chicago, Root Realty can help you. We’ll find you the right lender that perfectly suits your needs. If you have questions or want more information about how to find the right lender for your investment property, call us today.