Which Commercial Loan Suits You Best?
When you're ready to invest in commercial property, it's important to choose the right commercial loan. Part of a clever investing strategy is working out the most suitable property loan that will suit you and your situation!
There are many factors to consider, from interest rates and repayment terms to fees and charges.
This article will help you compare different types of lenders' commercial property loans so you can make the best decision for your investment.
Types of Lenders
When obtaining financing for a commercial property, there are a variety of lenders to choose from, but how they operate can differ significantly between them. So, let’s run through the three main types of lenders.
1. Major Banks
Most people are familiar with major banks since they are the most common type of lenders. They offer the advantage of an extensive branch network, though internet banking has made this less important for many people. Banks are generally owned by shareholders and are usually listed on the stock exchange.
2. Mutuals
Building societies and credit unions fall under ‘mutuals’, as members, not shareholders, own them. The major difference between mutuals and banks is the profits are reinvested for the members - whereas the profits solely benefit the shareholders.
Members of mutuals own their credit union or building society, whereas banks' customers
are not shareholders. As a result, members of a mutual may benefit from enhanced services and lower interest rates and fees in some instances.
3. Private Funders
Private lenders are generally a group of wealthy people who pool their money to lend funds at premium rates. Private lenders often have a greater risk appetite; however, this generally means high-interest rates and establishment fees. But, because the National Consumer Credit Protection Act does not cover their loans, they can be a lot easier and faster to obtain.
Types of Loans
How you structure the finance on your commercial properties is one of the most important parts of your investment strategy.
Commercial loans have far more variety than residential home loans are generally paid back over 10 to 20 years. However, the fees attached to commercial property loans can vary wildly, so it’s important to check these before taking on a loan. For example, a low-interest rate may not be cheaper than a higher rate with lower fees.
Here are some of the most common commercial loans you can choose from.
1. Fixed and Variable Interest Rate Loans
On most loan types, lenders may offer loans with fixed interest rates or variable rates. A fixed-rate loan allows you to lock in your interest rate for a set period, usually one to five years. During this time, your interest rate will stay the same, regardless of any changes to the official cash rate.
Variable rates, on the other hand, are much more flexible. Although your interest rate may fluctuate, you’ll have access to far more loan features such as redraw facilities.
2. Split Loans
A split loan has two components: a portion that a fixed interest rate applies to and another portion to which a variable rate applies. This allows you to manage the risk of interest-rate fluctuations in times of economic uncertainty in the fixed component and, at the same time, take advantage if rates drop with the variable part.
3. Principal and Interest
With principal and interest loans, you gradually reduce the amount you owe by paying off a portion of the principal each month. So, your monthly repayments are generally higher.
4. Interest-Only Loans
With interest-only loans, none of the principal amount is paid off during the loan term, usually three to five years. Once the loan’s term is completed, it will revert to a principal and interest loan unless the property is refinanced.
Interest-only loans are generally the most popular type of loan for commercial property investors because they’re more tax-effective and will increase a portfolio’s cash flow due to the lower repayments.
5. Full Documentation Loans
Most lenders will require full documentation loans - which requires you to submit a myriad of documents to support your application, including details of your income, asset base, outgoings and your debts.
6. No Doc and Low Doc Loans
If you’re self-employed, a contractor, or even a professional investor, it’s usually more challenging to provide all the financial documents to satisfy the lender’s requirements. ‘No doc’ or ‘low doc’ loans require less information about your assets and liabilities and are slightly more relaxed when it comes to the supporting documentation.
However, to mitigate the risk of granting a loan with little to no financial information, the lender will generally require a higher deposit and charge a higher interest rate.
7. Lease Documentation Loans
Lease documentation loans are excellent for investors who have several properties and cash and are reaching the limit of their loan serviceability. For a lease-doc loan, lenders solely look at the asset and the tenant involved to determine a borrowing amount based on the property’s net income.
8. Lines of Credit
A line of credit allows you to use equity from your principal place of residence or investment properties. With a line of credit mortgage, the money you borrow is usually secured against your equity in that property.
It functions similarly to a credit card: you have a pre-approved credit limit and can borrow as much of this as you want, paying interest on the outstanding balance.
9. Refinancing
Refinancing isn’t necessarily a type of loan. Instead, it’s the process of obtaining a new mortgage to reduce monthly payments, lower your interest rates, take cash for another purchase, or change lenders.
10. Commercial Bill Facility
Generally associated with high-end investment lending, a commercial bill facility allows you to raise the finance you need through negotiable bank bills. Essentially, you agree to pay the face value of the bill by a specified future date. These are relatively complex loans, so you’ll need to get advice from a seasoned investor and financial advisor.
11. Vendor Finance
Although not always commonly publicised, vendor finance is quite a common way of obtaining finance for a commercial property. Also known as an “instalment sale”, the seller (or vendor) sells the property using an instalment contract. Essentially, the buyer borrows funds from the sellers to buy the property.
Vendor finance is also relatively complex and involves several legal elements. If you’re interested in learning more about how this type of property loan works, I go into a great deal of detail in my book Commercial Property Investing Explained Simply - so make sure to check it out.
Key Takeaways
I hope this article has helped you to understand the different types of commercial property investment loans available. It is crucial that you take your time to find the right loan for you, as it can have a considerable impact on your success as an investor.
If you would like to know more about how I have helped thousands of clients successfully source and purchase quality commercial property across the country, get in touch today.