First Lien Position

When a lender is in a first lien position, it means that they are in the highest priority position to benefit from any liquidation of the property serving as collateral for the loan (in the event that the loan is in default and the property is to be sold).

An example of a first lien position would be the bank which holds the original mortgage on your property. The term primary lien holder refers to the lender who retains the first lien position; in the event another lender “subordinates” their position, that lender becomes a secondary lien holder.

Lien Position

Lien Position & Priority: What to Expect With Your Commercial Mortgage Up to $5M

When selecting a commercial mortgage, it’s also important to understand what lien position your lender will have.

A property lien is a legal right to the property that guarantees the underlying financial obligation for the investment property – i.e., the borrower’s obligation to repay the loan. If that obligation isn’t met, the parameters of the lien dictate that the lender can seize the property that is serving as collateral for the commercial mortgage.

The execution of a lien also means that the underlying property cannot be sold by the owner without the consent of the lien holder.

The issue of lien position relates to what happens if you, as a borrower, default on your commercial property loan. The lien position is especially important to understand in bridge loans, which borrowers often seek out to help them satisfy short-term capital needs and which (for lenders) can pose a high risk of default.

In the event of default, the lien position determines who has a right to receive proceeds from the ultimate sale (or “liquidation”) of the property. In most cases, for commercial loans up to $5M, the lender will require a 1st Lien position on the property.  For construction loans, the Lender may approve a 2nd lien position. Lenders in the InvestmentProperty.loans network specialize in first lien position mortgages.

For more information, request a quote to let InvestmentProperty.loans help you get started toward your new commercial mortgage.

Closing Costs

Commercial property loans are subject to closing costs once the transaction is finalized. The closing costs cover legal fees surrounding the transfer of assets and all associated paperwork.

Closing costs can be expensive, but are negotiable between the buyer/borrower and seller. As a buyer you can (and should) have it stated in the sale contract which party will be responsible for each cost at closing such as title insurance, deed stamps, surveys, and settlement fees.

But it’s important to note that lenders are not restricted in what they can collect from borrowers at closing: Your lender has a high level of discrepancy as to how much money you must put into escrow, how much they charge administration fees, points, and so on. All of these fees should be reviewed on your Term Sheet and Loan Commitment.

Because of this it is critical you negotiate all of the fees for your loan with your lender well in advance of closing, and that you work with experts who can connect you to the right loan offer for you.

Let InvestmentProperty.loans help you get started toward your new commercial mortgage.

Appraisals

Whether the financing is for a purchase, bridge loan, or refinancing, appraisals are necessary for lenders to confirm that the market value or purchase price of the property is accurate. Appraisals also help lenders determine if there are problems with the property that need to be factored into the loan amount or could affect the success of the transaction.

Appraisals for commercial properties are expensive.  They are ordered by the Lender, but paid for by the Borrower. Since the borrower does not want to have to pay for more than one appraisal, most loan applicants will wait until the lender has issued an acceptable term sheet before paying for the appraisal.

Fees

Other fees charged by commercial mortgage lenders may include application fees, loan administration fees, or underwriting fees, which cover the costs of underwriting borrowers’ loans. Fees are typically paid when the loan closes, though an application fee is often  charged earlier in the loan process.

If you work with a commercial mortgage broker, he or she may charge an application fee as well – so borrowers should closely scrutinize all fees charged to them in their property loan agreements, and should ask about fees before choosing to work with a commercial mortgage broker.

Application fees charged by a commercial real estate lenders sometimes cover the appraisal costs (though those may be charged to the borrower separately).In general, fees can vary broadly depending on the loan type and size of the property, and borrowers should be careful to compare fees among offers from multiple lenders. Borrowers can expect fees of ~$10,000 or more for loans up to $5M.

Points

Additional charges known as “points” may be part of your loan parameters. Points may be charged by lenders, brokers, or other intermediaries as a way to be paid for their work with your loan.

Points are paid at closing and represent a fixed percentage of the loan balance. (One point equals one percent of the loan amount.) Points are sometimes related to the creditworthiness of the borrower, but now always. Your commercial mortgage quotes from the lenders in the InvestmentProperty.loans network will detail information around points and other fees.

Loan Fees

Loan Fees & Other Costs: What to Expect With Your Commercial Mortgage Up to $5M

In selecting a commercial mortgage, the interest rate and prepayment fees are not the only costs involved. Borrowers should be mindful of all associated expenses, including points, closing costs, appraisals, and so on.

InvestmentProperty.loans is not a broker, so our experts can help connect you to the right loan with the most appropriate fees for your unique commercial mortgage needs.

Yield Maintenance & Defeasance

In large loans, the prepayment penalty may include a yield maintenance provision – sometimes called a ‘make whole.’ This penalty fee structure is intended to fully compensate a commercial mortgage lender for any lost interest between what the present rate is on the loan, and what the new rate is given the prepayment amount and the current interest-rate environment for the remaining term on the loan.

A large loan may also include a “defeasance” provision. As its name suggests, defeasance is a method of reducing fees in a commercial mortgage prepayment scenario: It allows borrowers to repay the loan by substituting the mortgage, and its stipulated interest rate, with a portfolio of securities (usually U.S.Treasury bonds).

However, both yield maintenance and defeasance provisions are only typical for large loans and rarely (if ever) affect loans under $5M.

Prepayment Penalties

Prepayment Penalties can come in many forms, so borrowers are wise to pay close attention to these specifications as they select the right commercial property loans for their needs.

For example, some banks or other lenders may charge a penalty for any prepayment - regardless of the size of the remaining balance or the remaining term of the loan. That said, most lenders will not charge a penalty if the prepayment is less than 10% of the original principal, or may waive the penalty in the event the property is sold or the borrower originates a new loan from the existing lender.

The penalty may take the form of a set fee (of say, $1000) or set percentage (of say, 1% of the original loan amount).

More often, however, the commercial mortgage will include much more complicated fee structures for the penalty that will vary in accordance with time. One example is a 5-4-3-2-1 structure, in which 5% of the remaining balance is the penalty if the loan is prepaid during the first year of its life, 4% in the second year, 3% in the third, and so on. This recognizes that the longer the remaining term of the loan the more value it likely has to the bank and the greater penalty necessary to compensate the lender.

Prepayment

Prepayment Conditions: What to Expect With Your Commercial Mortgage Up to $5M

Most commercial property loans – just like residential mortgages – are designed to be paid to full maturity, on a set schedule, through payments at predetermined intervals on predetermined due dates. So what happens if the borrower wants to pay down the loan early, or make larger than usual payments on the balance?

Due to the large sums of capital involved in the mortgage transactions, and the large portion of capital the lender receives from interest payments, commercial property loans typically include rules or restrictions around prepayments.

On very large, syndicated or securitized commercial mortgages, prepayments may not be permitted at any point during the life of the loan. This is known as a “lockout.”

Alternatively, some commercial mortgages may stipulate that prepayments can only be made after the borrower has paid on-schedule for a certain portion of the loan term – after the first two years (a “lockout period”) of a ten-year mortgage, for example. This is often seen with commercial property loans under $5M, which are a specialty of the experts at InvestmentProperty.loans.

On other occasions, the loan agreement between the borrower and the lender may include a prepayment penalty fee, which may include certain parameters around yield maintenance and/or defeasance.

Interest Only or "I/O"

Certain commercial mortgages may be available as I/O or “interest only” loans. These are loans in which the borrower only makes payments on the interest of the loan for a set period of time, starting at the beginning of the loan’s term.

During that period, the borrower does not need to make payments on the principal amount. After the set time period has elapsed, the loan is amortized to require payment on both the principal and interest.

I/O loans have pros, cons, and risks. New business owners may find them appealing as they look to get their businesses off the ground, since the have lower payments up front. But depending on the amount of capital borrowed, the risk of default is high: Monthly payments become considerably larger once the interest only payment period ends, since none of the principal balance has been paid down yet.

A select number of lenders in the InvestmentProperty.loans network offer I/O mortgages (typically for bridge loans or other short-term loans of 5 years or less). If you’re seeking an I/O lender, our experts will make sure you are connected to a mortgage that meets the unique needs of your investment property.

Rate Caps & Rate Floors

When a commercial property has a floating interest rate loan, it may come with a “cap” (or maximum limit) on the highest allowable interest rate during the term of the loan. It also may or may not come with a “floor” limiting the lowest allowable interest rate.

An interest rate cap helps minimize the risk for borrowers on a floating rate commercial property loan. Borrowers usually select floating-rate property loans with variable interest rates during periods when interest rates are very low; if the rates get even lower, the borrower benefits. But the borrower may end up with vastly increased financial risk if interest rates rise rapidly or significantly during the loan term.

For example, a borrower can get a 10-year commercial property loan which charges 4% interest with an interest rate cap of 7%. The interest rate can go up or down but will not go above 7%.

Capping the rate decreases the risk of default. The interest rate cap may apply during a specific period of the loan – such as the first 1-3 years – or for its entire lifetime. An interest rate“floor” works the opposite way, ensuring that the loan can meet the lender’s return expectations even if rates go down significantly.

Fixed or Variable/Floating

Commercial mortgage lenders offer rates that are either “Fixed” for the entire of the loan, or “Floating.” A floating rate (also known as a variable or adjustable rate) may move up or down depending on fluctuations in the rest of the market, or along with changes in a particular index.

Will the interest rate on your commercial loan be fixed or floating? Often, this choice is left to the Borrower, and many lenders offer both Fixed and Floating loans for a variety of property types.  

Recourse & Non-Recourse

Rates can also vary depending on whether the borrower receives a recourse or non-recourse loan. Lenders use different benchmarks for the different loan types.

Recourse debt holds the borrower personally liable for 100% of the debt, which often allows the borrower to have more flexibility to customize the loan structure and pricing. Recourse loans allow lenders to collect what is owed even after they have taken the collateral.

Non-recourse debt is exclusively secured by the collateral – in this case, the commercial property. If the borrower defaults, the lender can seize the collateral but cannot seek out the borrower for any further compensation, even if the collateral does not cover the full value of the defaulted amount.

Indices

Commercial mortgage rates fluctuate with market conditions, but are generally tied to the indices (or “indexes”) set by the federal government – such as the LIBOR, Prime, Swap, and Treasury indices. Most of these Indices also have multiple time frames that will also be chosen by your lender, such as 6 Month LIBOR, 10 Year Treasury, etc. It will also come with an additional “spread” of basis points over the designated term of the loan.

Spreads are determined by the lenders in InvestmentProperty.loans’ network, and vary depending on the selected loan product and term. They are also affected by factors such as the property type, property class, location, income, and borrower credit. Generally, spreads range between 200 and 250 basis points (2% to 2.5%).

How do spreads work?

For example, a lender may offer you a Freddie Mac multifamily loan with a spread of 225 basis points over the 10 Year Treasury Index rate of 2.37%. That means the  effective rate would be 4.62%, based on 2.25% + 2.37%.

Rate

Interest Rates: What to Expect With Your Commercial Mortgage Up to $5M

Commercial mortgage rates vary by property type, location, tenant mix, LTV, loan term and amortization period, and many other factors (including complex concerns like debt service coverage and deal sponsorship). Each of these are carefully considered in the underwriting of each individual loan.

Rates also vary widely depending on type of lender: Government lenders and banks typically offer the lowest but have the most stringent underwriting procedures and guidelines. Rates can also go up or down depending on how the lender sources their capital: Private lenders (which are supplying their own capital) tend to offer higher rates, but have significantly more flexibility in who they make loans to.

All commercial rates are based on indices (as we’ll explain below) but are also uniquely tailored to the needs, concerns, and objectives of individual commercial borrowers.

Once you submit your mortgage needs to InvestmentProperty.loans, our experts will help connect you to a mortgage lender with the right interest rate to meet your expectations. The lenders in our network specialize in analyzing property financials and calculating how to maximize returns for borrowers.

For “A” quality borrowers, interest rates often begin at around 4.5%.

For variable rate loans, rates are typically expressed as a base rate plus a spread over the index rate.

The base rate plus the spread indicates the starting rate for the loan. For example, a loan priced as “Prime +1%,” when Prime – a type of index rate – is at 3.25%, would have a starting rated of 4.25%.  Every time the Prime rate index moves up or down, the rate on the loan will also go up or down by the corresponding amount. Many loans also have rate floors and rate caps, as we’ll discuss below.

For fixed rate loans, rates are typically expressed simply as a percentage – for example, 5.25%. The lender will have settled on this rate based on their analysis of the index and spread, but the rate will not change during the duration of the Loan Term.

Balloon Payment

A balloon payment occurs when the amortization schedule is longer than the loan term. To use an example, let’s say a borrower has a $1 million commercial loan with a term of 7 years at a 7% interest rate, with an amortization period of 30 years: The borrower would repay the loan for seven years at an amount based on the loan being paid off over 30 years – so the borrower would make monthly payments of $6,653.02 for a full seven years.

At the end of the 7-year term, the borrower would make one final “balloon” payment of the entire remaining balance on the loan. A final balloon payment of $918,127.64  would pay off the loan in full.

The larger the differential between your loan term and your amortization period, the larger the balloon payment you will need to make at the end of your loan term. That can potentially put you at risk of needing to refinance the property.

Amortization

Your “amortization” is the distribution of loan repayments into a series of cash flow installments. Each repayment pays a portion of both your principal balance and your accrued interest.

When you obtain a commercial mortgage, all of your repayment details are set out in an amortization schedule (which is the schedule of loan payments over the life of the loan). Your amortization schedule factors in the amount of principal and the amount of interest that comprise each payment until your commercial loan is paid off at the end of the loan term.

In some instances, the loan terms and amortization schedule cover the same time period – allowing you to pay off the mortgage with your last repayment. Unlike residential mortgages, however, commercial loans often have an amortization period that is longer than the term of the loan.

With a longer amortization period, borrowers make repayments during the loan term that reflect the payment amount as if the loan were to be paid off over the entire length of the amortization period. For that reason, when a commercial mortgage has an amortization period that extends beyond the loan term, the loan is paid off with a final balloon payment.

Loan Term

Your loan term is the amount of time it will take you to pay off your commercial mortgage according to the conditions established between you (the borrower) and your lender. The length of the loan term will affect the interest rate that a commercial lender will charge you as a borrower for the mortgage on your investment property.

The terms of commercial loans typically range from 5 years (or less) to 30 years. In general, you will pay a higher interest rate if you seek a longer-term loan: For example, you would likely pay a higher interest rate on a 15-year loan than on a commercial mortgage with a 7-year term.

The loan term and amortization schedule offered to you by a commercial lender translate directly to:

1.) how much you pay with each loan payment; and

2.) how long you pay back your commercial mortgage

Loan-To-Value

LTV or Loan-to-Value Ratio: What to Expect With Your Commercial Mortgage Up to $5M

The “Loan to Value Ratio” is calculated by dividing the mortgage balance by value of the commercial property, and multiplying that number by 100%. It can be computed with the following equation:

Loan Amount / Value of the Property x 100 = Loan-To-Value Ratio

The LTV offered to you by a commercial lender translates directly to how much you can borrow with your loan. It represents the maximum level of risk a lender wants to take on with your loan. A higher LTV represents a riskier loan for your commercial mortgage lender, and a lower LTV represents a “safer” loan.

Before securing a loan, you need to know two things to understand what to expect from your LTV: Your desired loan amount, and the value or sale price of the investment property you are trying to buy or refinance, or improve through a renovation, stabilization, or rehab project. Keep in mind that most commercial lenders require a down payment between 20% and 30% of the property purchase price.

To use an example, let’s consider a property valued at $1.2 million. If you want to buy the property, but can only put down $240,000 of capital (or 20% of the property value), you will need a $960,000 loan in order to complete the purchase. That means you need to find a lender offering you an 80% LTV.

$960,000 / $1,200,000 x 100 = 80% LTV

Notably, the LTV is based on the lower of the sales price or property value. That means that if you’re buying the property for $1.2 million, but it was appraised at $1.4 million, you are subject to the lower sale price, not the higher valuation of the appraisal.

Note: In the event there is more than one mortgage on the property, the combined loan-to-value ratio is used instead. The combined loan-to-value ratio is the sum of the first mortgage plus the second mortgage, all divided by the value of the commercial property, the result being multiplied by 100%.

Combined LTV = ((First Mortgage + Second Mortgage) / Value of the Property) x 100%

80% is the typically the highest LTV available to commercial borrowers. The lenders in the InvestmentProperty.loans network offer loan-to-values ratios up to 80% for multifamily properties. (1- to 4-unit multi-family properties, which often fall outside the preferred loan parameters for large-balance commercial lenders, are a specialty of our commercial mortgage lenders).

Typically, the highest LTV typically offered on business properties and other commercial investment properties (spanning mixed-use, office, retail, and special-purpose properties and ground-up development projects) is a loan-to-value ratio up to 70%. This is true for bridge loans and refinancings, as well.

Most hard money commercial loans are limited to just 65% LTV or lower.

Determine what LTV can help you meet your goals with your investment property, then get a quote here on InvestmentProperty.loans.

Let us connect to you to the right lender today to get started toward your new commercial mortgage.