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Some people get commercial mortgages to buy their own business space. Others get them to invest in real estate. Whatever the reason, there are at least 6 essential terms that commercial mortgage borrowers need to be familiar with before signing on the dotted line.

1. Amortization
Commercial loans are amortized, meaning that the principal and interest required are spread out together over the life of the loan. That means every payment includes both principal and interest. Yet commercial loans often have terms as short as five years and generally do not extend beyond 20 years. In order for monthly payments to be reasonable in so short a time, many commercial mortgages are amortized beyond the length of the loan which means a large “balloon” payment will be due at the end of the loan term. Often borrowers refinance these balloon payments into new loans, but investors do need to be prepared for that day.

2. Debt Service Coverage Ratio
Also known as DSCR, the Debt Service Coverage Ratio is a comparison of the annual net operating income generated by the mortgaged property and the annual loan debt costs. This ratio helps to determine if the loan is financially sound and how large the loan should be.

3. Interest Rate
Interest rates on commercial mortgages can be fixed rates or adjustable rates, but they are typically higher than those of residential mortgages. This is because they are generally for much larger sums and incorporate more risk.

4. Loan-to-Value Ratio
Also known as LTV, the loan-to-value ratio measures the value of the loan compared to the value of the property. The lower the LTV the more equity the borrower will have in the property and the less risky the loan is to the lender. Most lenders require an LTV between 65 and 80 percent.

5. Prepayment Penalties
Commercial real estate loans often come with prepayment penalties. This is to ensure the lender recoups his costs and some profit on the mortgage in case it is paid off quickly. The penalty could be a percentage of the outstanding balance or it could be a preset amount of interest. There may even be a clause that blocks the borrowers from paying the whole loan off within the first five years or so.

Armed with a basic knowledge of these terms, potential borrowers can be much more confident going into a commercial mortgage.


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