If you’re a homeowner, you’re probably familiar with how residential mortgages work.

For home loans, a 20% down payment used to be standard, but the median for first-time homebuyers is now 7%.

But if you’re looking to finance a new retail storefront, office space, manufacturing facility, or rental property, you’ll need to understand what sets commercial real estate (CRE) loans apart. In this article, we’ll cover three key differences between these lending products and offer tips for preparing to succeed.

1. Types

   For single-family homes, there are two basic types of mortgages: conventional and government-backed. Conventional mortgages are commonly issued by banks and credit unions. Government-backed mortgages are insured by one of several federal agencies and are designed to reduce lender risk and make it easier for homebuyers to qualify.

   For commercial properties, there are more options to consider. Conventional loans are widely available from traditional lenders. Two major loan programs are backed by the Small Business Administration: the 504, which can be used for real estate and other major fixed assets, and the 7(a), which has a broader range of uses.Bridge loans are meant for business operators who need to access capital while a property is being renovated, leased, or refinanced. Mezzanine loans are sometimes used to fill the gap between a primary mortgage and the amount of cash that the borrower can raise. Finally, hard money loans may be a last-resort option for entrepreneurs who have less-than-stellar credit but need to move fast on an opportunity.

2. Eligibility

   When you’re buying a home, lenders want to see that you have sufficient income to cover your mortgage payments and a solid track record of managing debt obligations. They’re likely to look at your recent paystubs and tax returns as well as your personal credit reports and scores. The 28/36 rule may come into play too: total housing costs shouldn’t exceed 28% of your gross income, and total debt payments (including the new mortgage) shouldn’t exceed 36%.

   Commercial lenders have the same essential concerns, but they use different tools to determine if you’re qualified. They will probably calculate your debt-service coverage ratio, which is given by the formula: (net operating income)/(total debt service). As an example, if your property can generate $600,000 per year and your principal and interest payments amount to $400,000 per year, you’d have a DSCR of 1.5. Many CRE lenders look for a DSCR of at least 1.25, but requirements vary depending on your industry and other financial indicators. And when it comes to credit history, they may consider your business credit reports and scores from Dun & Bradstreet, Equifax, and Experian instead of or in addition to your personal reports and scores.

3. Terms

   Home loans come in many varieties. They may be fixed-rate or adjustable-rate, with terms of 15 to 30 years. A 20% down payment used to be standard, but the median for first-time homebuyers is now 7%, with mortgage insurance due until equity reaches 20%. Prepayment penalties are rare.

   CRE loan terms also vary by lender and situation, but the norms are different. Overall, CRE lending is a riskier proposition for lenders, so interest rates and closing costs tend to be higher, and requirements are more stringent. Loans may come with a fixed or adjustable rate, but you’re more likely to encounter shorter loan terms (e.g., five to 20 years) with a longer amortization period. That means you’ll owe a one-time balloon payment at the end. As for down payments, you can expect to put down about 10% for an SBA loan, or at least 25% for a conventional loan. And unlike most home loans, you may be subject to sliding scale penalties if you pay off your balance early.

Optimizing Your Position

If you’re looking to secure a CRE loan with the best possible terms, you’ll need to learn how lenders make their decisions. Review the six C’s of creditworthiness and take action to boost your borrowing potential:

• Capital: Your assets compared to liabilities and the amount of money you’ve invested
• Capacity: Your income and cash cushion to support debt and unexpected expenses
• Collateral: Including cash, receivables, equipment, and other real estate holdings
• Conditions: Including external factors such as the economy, trends, and regulation
• Character: Including your personal experience, credit history, and judgments or liens
• Communication: How you present your business plan and continue the dialogue

Once you’ve gotten your finances in shape, you’ll want to start organizing your documentation. Be prepared to show your firm’s revenues, expenses, debts, receivables, and cashflow. Additionally, you may want to use forecasting tools to project future income. CRE lenders understand that business comes with no guarantees – but showing that you’re setting practical goals can go a long way toward establishing a solid partnership.

Ready for Your Big Move?

To explore all your borrowing options, reach out to your financial institution.