Do you use commercial loans?

[Brandon Handel]

Just curious how many of you choose to finance through commercial loans on small properties (i'm thinking 4plex) that a conventional loan can finance. I talked to a commercial banker recently and he told me everyone comes back to the commercial bank for loans. The idea of a rate reset every 5 years when I can just go and get a fixed rate seems like poor logic. Especially when it's going to be higher than a conventional loan to start.  I know interest rates are rising so who knows what it'll be like 5 years from now. He argued it'll be paid down quicker, but I argue that I can just make extra payments on the principle if I want that and I won't need to worry about a commercial loan eating my cash flow either because it's my option as to whether I want to pay extra or not. Also, say the economy tanks or the interest rates are just really high after the reset, I can ride the storm out better I would think with a conventional loan since it would require lower payments than the conventional loan. He argues I can sell if that happens, but why would i want to? Higher interest rates = lower property values. I know banks make money off interest. Is this guy just trying to make money off of me or am I missing something? That's my thought process on the whole thing anyways. Would love to get some input from others. Thank you

[Albert Bui]

Originally posted by @Brandon Handel:

Just curious how many of you choose to finance through commercial loans on small properties (i'm thinking 4plex) that a conventional loan can finance. I talked to a commercial banker recently and he told me everyone comes back to the commercial bank for loans. The idea of a rate reset every 5 years when I can just go and get a fixed rate seems like poor logic. Especially when it's going to be higher than a conventional loan to start.  I know interest rates are rising so who knows what it'll be like 5 years from now. He argued it'll be paid down quicker, but I argue that I can just make extra payments on the principle if I want that and I won't need to worry about a commercial loan eating my cash flow either because it's my option as to whether I want to pay extra or not. Also, say the economy tanks or the interest rates are just really high after the reset, I can ride the storm out better I would think with a conventional loan since it would require lower payments than the conventional loan. He argues I can sell if that happens, but why would i want to? Higher interest rates = lower property values. I know banks make money off interest. Is this guy just trying to make money off of me or am I missing something? That's my thought process on the whole thing anyways. Would love to get some input from others. Thank you

I originate conventional loans and use both in RE investing and will say that there are pros and cons to each.

For conventional there are the obvious ones which are fixed term and amortization for all 30 years. The downside is restrictive guidelines, a ton of paperwork, lack of flexibility.

Commercial types of financing have pros that are flexibility in guidelines and structure you can do all sorts of stuff from substitution of collateral to partial lien releases on blanket commercial mortgages to cross collateralization and many others, less documentation than conventional financing products, use of debt coverage ratio (DCR) as opposed to Debt to income (DTI) and if you compare DCR to DTI the commercial lenders go up to 80% DTI since the reverse of 1.25x DCR is .80 or 80%.

There are downsides to commercial financing and that is the convenants with in the mortgage note that can allow the lender to call the note so make sure to read all the definitions for what substantiates a "default," by the lender you'll be surprised by the definitions and language at times. 

On Commercial notes from community banks and credit unions you may notice that the loans will balloon at the end of the term period and often times the term is shorter than the period they amortize for your monthly payment so at the end of the term you're left with a sizeable balance to payoff or refinance again. This requires a bit more planning to make sure you never term out of your commercial mortgage during a period of time when values are not favorable for a refinance like at the bottom of a market cycle.

So with sufficient foresight and use of the pro's while minimizing the con's I side with commercial financing from a RE investor perspective, but for the newer aspiring investors I will side with conventional since its financing with training wheels that favor the borrower. When you're starting out you may want to focus on the real estate itself rather than focusing on the nuances of financing terms and conditions.