Confused about commercial loans can someone help me understand
Bluffton , SC · Member since 2015 · 75 posts · 9 votes
What are you unclear about? This is typical for commercial loans. The payment is calculated based on a 20 year term. But, unlike a 20 year fixed rate loan, the loan is due after five years. So, for example, if you take out a $1 million loan at 4.5% with a 20 year amortization period your monthly payment (P&I) would be $6326.49. After five years you would have a principal balance of $826,999.90. You would need to pay off this loan or refinance it. You might, or might not, be able to refinance with the same lender. You might have to find a different lender. Or you might have to sell. If you cannot sell, refinance or pay off the loan, the lender would foreclose and you would lose the property.
I'm in a mini-storage deal where we came very close to losing the property when the original loan ballooned. We had to do a cash-in refi because the new lender would not loan enough to fully pay off the original loan. And we paid for several extensions on the original loan to give us enough time to refinance.
Prepayment penalties are also common on these loans.
What are you unclear about? This is typical for commercial loans. The payment is calculated based on a 20 year term. But, unlike a 20 year fixed rate loan, the loan is due after five years. So, for example, if you take out a $1 million loan at 4.5% with a 20 year amortization period your monthly payment (P&I) would be $6326.49. After five years you would have a principal balance of $826,999.90. You would need to pay off this loan or refinance it. You might, or might not, be able to refinance with the same lender. You might have to find a different lender. Or you might have to sell. If you cannot sell, refinance or pay off the loan, the lender would foreclose and you would lose the property.
I'm in a mini-storage deal where we came very close to losing the property when the original loan ballooned. We had to do a cash-in refi because the new lender would not loan enough to fully pay off the original loan. And we paid for several extensions on the original loan to give us enough time to refinance.
Prepayment penalties are also common on these loans.
Ultimately, thats a pretty good commercial loan to be honest. The plus that I see is the 15% down payments. Thats really good for a commercial loan. Usually i see a minimum of 25 to 30% down payment on commercial loans.
That being said, that may also be the piece that trips you up. Typically, when you put down 25 to 30% and then pay 5 years on a 20 yr amortized loan, your ltv ends up pretty good assuming even a little appreciation. So even if the current bank loses its mind and doesn't renew the loan at the end of the 5 years, its easy to go somewhere else because you have a strong ltv.
But at 15% down, you do run the risk of having no appreciation or negative appreciation and then trying to renew a loan at say 90 or 95% LTV and nobody willing to take it.
What I can tell you is that, as long as you pay your bills on time and as long as there is no bust in the market, your chances are fairly good that the bank is going to renew the loan.
If you are really concerned about the renewal aspect, there are some local banks doing commercial loans that will simply reset their rate after the 5 year period but you don't have to refi/renew the loan all over again after the 5 year period.
I think banks have caught on that doing the auto renewal with the rate reset is far better for them and their borrowers. No risk of having a market crash and then being unable to refi the loans which saddles them with a bunch of properties they really don't want. Yet, they're still able to manage the interest rate risk by allowing the rate to float after that 5th year.
In the end that becomes a better product for them. If doing a typical loan and I refi the property after the 5 year period, I get to lock in the new rate for another 5 years. By doing the auto renewal, they are able to float the rate every year thereafter and basically hedge the loan for any interest rate spikes that might occur.
To me, I wouldn't worry as much about the 5 year balloon though. The chances are highly likely the bank will do the renewal provided you pay your mortgage on time with them and some crazy crash doesn't hit. I would guess 50 or 60% of the commercial loans are structured that very same way today.
If the numbers work, take it down.
Do not assume the existing lender will renew. Certainly not "without a hassle". In our case, they reviewed five years of financial performance. The first two years had weak results while we were turning the property around and that reduced the value. That's what led to the cash in part of the refi. We went through multiple lenders trying to find one that would do the refi, and spent non-trivial sums of money with each of those as part of trying to get the loans.
Now, that was a different time. We bought that in 2007 and were trying to refi in 2012. Times are different now, so a refi would probably be a lot easier now than five years ago. That said, will 2022 be like now? Or more like 2012?
Nevertheless, this is how the game works for this sort of loan.