Can you use a Commercial Loan to buy a house?

Types of Commercial Real Estate Loans (Including Non-Qm)
September 14, 2022
Is it harder to get a Mortgage for an Investment Property?
September 14, 2022

Virtually everyone dreams of owning a home. Besides the pride and satisfaction in knowing that you never again have to worry about a place to lay your head, there is the obvious fact that buying a home is a valuable investment. Investing in a house is an excellent way to diversify your portfolio. You can use your house as leverage to buy other properties or as collateral to get loans for other investments.

When it comes to buying a house, the first question on everyone’s lips is, “where do I get the money from?” Unlike stocks or cryptocurrencies, you can’t invest in property with “little change.” You need massive capital, which you often don’t have lying around idly. This is where loans and mortgages come in. You can collect loans from banks, insurance companies, credit unions, and other financial institutions to fund your house. Of course, these loans require that you fulfill certain conditions and pay interest on the initial sum you collected. However, the pros often outweigh the cons, especially when you get your house cheaply and it appreciates in value over the years. Now, there are different types of loans available, one of which is commercial loans. Here, we’ll discuss what commercial loans are if you can use them to fund your house purchase, and other options for buying a house. Keep reading!

What are Commercial Loans?

Commercial loans are debt-based funding organizations take to finance operational costs or major capital expenditures. There are several commercial loans, each with unique terms and conditions. Generally, commercial loans can be classed as short-term, payable within 12 months, or long-term, that last for longer periods. Although commercial loans are mostly used by medium to large-scale businesses, small businesses can also obtain them to fund immediate costs, provided they meet the credit score requirement.

There are several types of commercial loans, including;

  • Commercial real estate loans
  • Working capital loans
  • Accounts receivable financing

We’ll be focusing on commercial real estate loans, which is the type of commercial loan taken to buy a property

Commercial Real Estate Loans

As the name implies, real estate loans are loans taken to purchase or invest in physical properties. Real estate loans may be in the form of mortgage loans, in which the loan is secured by the property being purchased, or non-mortgage loans, in which the loan is unsecured.

There are generally two types of real estate – residential real estate and commercial real estate. Commercial real estate refers to any property with income-generating potential. Financial institutions typically treat a property as commercial if at least 51% of that property is directed towards the owner’s business. The following property types qualify for commercial real estate loans;

  • Apartment buildings: Any residential building with five or more living units is classified as commercial real estate and can be purchased with a commercial loan. Otherwise, if the building has less than five units, then it is classified as a residential property.
  • Offices and retail buildings, including malls and shopping complexes
  • Medical facilities
  • Hotels and resorts

Commercial loans are typically used for financing, including acquiring, developing, and constructing these properties.

Types of Commercial Loans

Before taking a commercial real estate loan, you need to understand the different types of these loans and the terms associated with each to understand what works best for you.

Term Loans

Term loans are the most basic type of commercial loan. Here, the bank lends you some money with agreed repayment terms. The loan may be short term (less than 12 months), medium term (between 1 and 3 years), or long term (more than three years). The major requirement of this loan type is that 51% of the property is occupied by your business. These loans also require you to have a FICO credit score of 700 or more and to have been in business for at least one year.

A term loan may be backed by collateral, in which case the banker bears less risk and issues lesser interest rates. However, if the loan is not backed by collateral, the bank bears more risks, resulting in a higher interest rate. The interest rate on a term loan may be fixed or variable, and the bank places fewer restrictions on the money, allowing you to use it for whatever you want in the business.

Hard money loan

Hard money loans are short-term, high-interest loans commonly obtained as a last resort to finance a property. These loans are rarely given by banks but rather by private investors willing to take risks based on the value of a commercial property. Hard money loans offer you a quick way to raise money, as the investor is typically unconcerned about your credit rating or income. However, this quick money comes at a great cost as these loans have interest rates between 10-18% and typically last less than 24 months. In addition, the upfront fees you pay are costlier.

While hard money loans may seem risky for the lenders, they usually have the backing of commercial property as collateral. If borrowers default on payment, the lender can take over the property to recover their money. For a borrower, hard money loans are ill-advised unless there is a guarantee of flipping the money in time.

Bridge loan

Bridge loans are relatively short-term, high-interest rate loans that provide quick cash flow for a business to meet immediate obligations until they can secure financing. Bridge loans can be considered a milder and safer version of the hard money loan. These loans are provided by banks with interest rates of up to 9% and terms of up to three years.

Bridge loans have shorter approval times and often require that you have a credit score of at least 650, cover a 20% down payment, and provide collateral (property or inventory) to back the loan. Bridge loans essentially help you bridge the gap between a period of no finance to a period of adequate financing. You may consider a bridge loan in a case where you need money to finance the purchase of a new house while waiting for a current property to sell.

Construction loan

As the name sounds, construction loans are medium-term (18 months to three years) loans taken to cover the cost of constructing a property. Construction loans help you cover the cost of materials and labor when building structures like offices, retail fronts, industrial facilities, multi-family rental units, etc. When taking a construction loan, you can use the property on which you are constructing as collateral.

Blanket loan

A blanket loan is a single real estate loan that can be used to finance multiple properties at a time without any individual property affecting the loan terms. Blanket loans allow real estate investors to acquire multiple properties quickly and make money off those properties without incurring any penalties. On the downside, blanket loans are complex, difficult to get, and have higher interest rates and down payments.

For example, if you identify 10 different properties on the market, you can collect a blanket loan to acquire and refurbish all 10 f those properties. Depending on the loan terms and the agreed release clause, you can sell off some of those properties to individual buyers and then use the money to invest in other properties rather than pay the loan. Your blanket loan is still valid, provided you hold some of the property covered under the loan.

Fix and Flip

These are short-term (typically between 6 and 18 months), high-interest (typically between 12 and 18%) real estate loans provided to investors looking to renovate a property and flip it for a profit in the short term. These loans are a type of hard money loan provided to investors looking to acquire a property on auction or foreclosure. The loan offers extra money to renovate said acquired property and then flip it for a profit.

Characteristics of Commercial Loans

Commercial loans are different from other types of loans. If you want to finance a property using a commercial loan, there are certain characteristics of this loan that you must be aware of, especially in comparison to residential loans. They include;

  1. Loan source: Unlike residential loans, which can be gotten from any major bank or mortgage lender around the nation, commercial loans tend to be given by local banks in the city where the commercial property is to be purchased. Thus, if you want to finance a commercial property in, say, Chicago, you must have a good relationship with the local banks in Chicago.
  2. Interest rate: The interest rates on commercial loans are generally higher than that on residential loans. In addition, commercial loans typically require that you pay certain fees like appraisal and loan origination fees which make the terms on these loans higher.
  3. Amortization: Amortization refers to the length of time it would take to fully pay off a loan. Unlike residential loans, which are typically amortized over 30 years, commercial real estate loans typically have shorter amortization. This short-term amortization allows the loaning institution to incur less risk while receiving higher payments each month. For you, the borrower, such short-term amortizations may impair your cash flow significantly.
  4. Variable interest rates: With commercial loans, your calculated interest rate is usually tied to a standard index and will vary according to the movement of the index. This means that if that index goes up, then the interest rate will go up, and if the index goes down, then your interest rate will go down. Although the shorter amortization period lowers the risk for both lender and borrower, there are often cases where the interest rate may skyrocket or plummet over short periods.
  5. Down payment: Typically, when collecting a real estate loan, you have to put in a down payment (although some institutions may allow you to take a real estate loan without a down payment). With residential loans, this down payment may be about 25%. However, with commercial loans, the percentage is typically higher, especially when you do not have a seasoned relationship with the local bank which you are borrowing from.
  6. Prepayment penalty: Commercial loans usually have prepayment restrictions designed to preserve the lender’s yield on the loan. These restrictions come in the form of prepayment penalties which a borrower pays if they settle a debt earlier than the loan’s maturity date. There are different types of prepayment penalties, including; basic prepayment penalty, interest guarantee, lockout, and defeasance.
  7. Qualification: Unlike residential loans, where your qualification for the loan depends on personal circumstances like income and credit score, qualifying for a commercial loan usually depends on the potential of the property which you want to finance with the loan and how much money such property can generate. Generally, your qualification for a commercial loan is a tradeoff between your personal income and the potential or actual income of the property. The more the property generates, the less important your income becomes and vice versa. Other qualifying criteria for commercial loans include;
    1. Your experience in dealing and making money from real estate
    2. Your total assets besides the financed property
    3. Your relationship with the lender

Buying a House with a Commercial Loan

Now to the main question in this piece, “can I use a commercial loan to buy a house?” Well, the simple answer is, it depends. Commercial loans are specifically made to finance the purchase or development of commercial properties, i.e., properties used for business-related purposes rather than residential ones. This means that such property must generate income for you, the owner, either through business income, capital gains, or rentals. Many properties may be classified as commercial properties, including multifamily housing units. However, if you intend to get a regular house for you and your family to live in, then you would typically not qualify for a commercial loan.

Now, even if you could get a commercial loan to buy a house, you’d have to consider its worth. Commercial loans typically have higher interest rates, shorter terms, and lower loan-to-value (LTV) ratios than residential loans, thereby impeding your cash flow. However, you could consider taking a commercial loan for your private house under the following scenarios;

  1. Buying a house in the name of your LLC: Using commercial loans to purchase a property helps you avoid the rigors of quitclaiming the property, triggering a due on sale clause, or losing title insurance on your property.
  2. Not qualifying for a residential loan: Regular banks will rarely grant you a residential loan without an adequate W-2 income history and a good credit score. If you fall under this category, it might be easier to get a commercial loan since such loans typically depend on the potential of your property rather than your personal finances.
  3. Maxing out your residential loan limit: There is a limit to the number of residential loans you can take. As an individual, you have a maximum of 10 residential loans; as a couple, you have a maximum of 20 (10 in each person’s name). Once you reach your residential loan limit, you can only take out commercial loans.
  4. Buying a house to resell: If you quickly want to flip a property, you may be able to take a commercial loan.

What other Loan Options are available?

Rather than taking a commercial loan to finance a private property, you could try an alternative such as a non-QM loan.

Non-QM loans

Non-qualifying mortgages do not meet the Consumer Financial Protection Bureau’s “ability to repay” rule set for qualified mortgages. Thus, lenders can offer you loans without vetting your finances or offer you amounts higher than what you would be able to pay back.

Non-QM loans are highly risky for the lender, who, rather than verifying your income with tax returns, W2s, and paystubs, might use your bank statements to calculate your income to qualify you for the loan. The lender may also offer you great flexibility through interest-only payments, negative amortizations, or a longer loan term. Conversely, you’ll likely pay higher rates, APRs, and even upfront fees and points that aren’t permitted on qualified mortgages. However, you will be able to settle your loan over longer periods. An advantage of non-Qm loans is that you can access them within days of a major credit event like bankruptcy.

If you have found your dream home, but do not qualify for a standard mortgage, then a non-QM loan is right for you. A non-QM loan may provide a temporary lending solution until you meet regular mortgage standards and can refinance to a traditional loan. You can benefit from a non-QM loan if you;

  • Are self-employed;
  • Have reached your residential loan limit;
  • Have a bad credit score or a recent bad credit

For the best non-qualifying mortgage rates to buy an investment property, contact Aurum $ Sharpe today.

Bottom Line

Although difficult, you can indeed buy a house with a commercial loan. However, with its short-term and high-interest rate, a commercial loan may not be your best option to finance a private property. Instead, you should consider a non-QM loan offering more flexible terms. Need to discuss available options on non-qualifying mortgages, then contact me today at 9177404325.

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Bryan Hanley
Bryan Hanley
Bryan has been working in the mortgage industry since 2005. He has worked at banks such as JP Morgan Chase, The Federal Savings Bank, and Santander Bank. He published a book about mortgages for entrepreneurs called "The House Hustle" in 2014 (https://www.amazon.com/Insider-Secrets-Buying-Black-Entrepreneurs/dp/1980478368), and co-owns Aurum and Sharpe