Answers to what you should know when getting into commercial lending:
What should I know getting into Commercial Lending?
First it is important that you understand that commercial lending has many similarities to residential lending that residential loan officers aren't aware of. First things first, you must realize that lending is lending and a mortgage is a mortgage. The process and underwriting of a commercial loan is the same as underwriting a residential loan with a few more steps added. BUT, the few more steps are nothing to prohibit you from adding commercial lending to your business.
What's common between commercial lending and residential lending? You need a 1003, credit report, tax returns (three years instead of two), asset statements (personal financial statement), appraisal, and a schedule of real estate owned with a debt schedule.
In addition for a commercial loan, you need a recent income and expense statement on the business (P & L), if it's a non-owner property, you need an income and expense statement on the owner (usually an LLC - it will usually show rental income and expenses associated with the property). You will also need a rent roll (if there are tenants), a resume on the borrower(s), a projected pro-forma on how the business will perform (only if it's an owner occupied business or single tenant), and additional third party reports such as a Phase 1 environmental.
With this information, you have 95% of what is needed to make a decision whether or not you have a viable loan; the last 5% is knowing how and where to place it.
The hardest part in the commercial loan process is getting all of the information needed to perform a thorough underwrite. With the information mentioned above, we will know if it will qualify or not. The last thing you must know is that a commercial loan is a story and not a scenario and you must be prepared to educate the client that it will take more then a pricing engine to determine the interest rate. That being said, here are the answers to some questions you might come across in dealing with a client wanting a commercial loan.
How are commercial loans amortized?
Commercial loans are generally amortized over periods of 15,20, 25, or 30 year terms. However, there are variable rate commercial loans that have an interest only payment with a certain stop.
What are the terms of a commercial loan?
Commercial loans generally have terms of 2, 3, 5, 7, and 10 years. The only exception is in the SBA 504 program. The bank loan has a term of 5 or 10 years, but the SBA portion of the loan is a 20-year term. Recently there have been products that were created with a longer fixed period (15 - 30 years), but the rates tend to be higher
Can you explain recourse and non-recourse loans?
Non-recourse is a mortgage or deed of trust securing a note without recourse allowing the lender to look only to the collateral (property) for repayment in the event of default, and not personally to the borrower. A loan not allowing for a deficiency judgment. The lender's only recourse in the event of default is the collateral (property), and the borrower is not personally liable.
So, recourse, as you can deduce is personal liability for the mortgage or deed of trust by the borrower or guarantor.
Can you explain the difference between 3rd party fees and loan fees?
Third party fees include: Appraisal, environmental reports, engineering reports, and surveys. These are fees that are paid upon acceptance of the LOI by the borrower. In other words, if the borrower signs and dates the LOI accepting the terms, they send a check or wire Nova Commercial Loans for the 3rd party fees listed on the LOI and send both to this office. Once received, the reports are ordered and the 3rd parties are paid. This money is non-refundable.
Loan fees may include: origination fees, processing, underwriting, appraisal review fee, appraisal processing fee, lender fee, credit report, flood cert, tax service, UCC (Uniform Commercial Code) fee, automatic payment decline fee (if applicable). These are fees that are paid at closing.
What is an LOI?
LOI stands for Letter Of Interest and sometimes Letter of Intent. An LOI contains the following information:
Loan amount
Term
Amortization
Interest Rate
Whether or not the loan is assumable
Whether or not it is recourse or non-recourse
Approximate Loan Fees
Approximate 3rd Party Costs
Timing
Prepayment Penalties
Conditions
Confidentiality Statement
What is the commercial loan process?
1. The Loan Officer fulfills the items on the Needs List and sends them to the office to get a quote.
2. Within 48 hours, we will get you a quote (or require more information) along with an LOI.
3. The borrower signs and dates the LOI if they accept the terms.
4. The loan officer returns the signed LOI along with a check from the borrower made out to Nova Commercial Loans for the 3rd party fees to the office.
5. We order an appraisal and environmental reports if required.
6. The file is packaged up and sent to the investor to see if there are any further conditions needed.
7. We address any conditions or additional needs from the investor.
8. Docs are drawn.
9. We close the loan.
What are the prepayment penalties for commercial loans?
There are 3 main types of prepayment penalties in commercial lending:
1. Declining or Step-Down
2. Defeasance
3. Yield Maintenance
What is a Declining or Step-Down Prepayment Penalty?
A Declining Balance is the "traditional" prepay penalty structure. With this structure, the borrower may repay the loan prior to the balloon by paying a penalty equal to a certain percentage of the loan amount, and this percentage declines over time. For example, if there is a 5 year step-down prepayment penalty, in year 1 your client will have to pay a prepayment penalty of 5 years, in the 2nd year, of 4 years, etc...At year five the borrower might have a window in which there is no prepay penalty, after which the declining balance would start over again. 1- to 3-months before the loan comes to term, the borrower might again be able to pay the loan off without penalty.
What is a Defeasance Prepayment Penalty?
The most common form of prepayment penalty is a defeasance formula. The legal definition of defeasance is, "A provision in an instrument that nullifies it if certain acts are performed." When a borrower wants to pay off a fixed rate commercial mortgage loan, there is a clause in the mortgage that gives the borrower the right to prepay a commercial mortgage but first they must perform an act; they must purchase US Treasuries in an escrow account. They must give to the lender a bundle of U.S. Treasuries that provides the lender with the same stream of interest payments and the same balloon payment as the original mortgage. Buying and assembling these U.S. Treasuries is immensely expensive, often on the order of 15% to 20% - and sometimes 25% - of the principal balance on the loan!
What is Yield Maintenance Prepayment Penalty?
According to a Yield Maintenance penalty, the borrower essentially must make up the difference between the amount of interest that would be earned on the loan if it were carried to term and the amount of interest that would be earned if the lender reinvested the borrower's prepaid principal in treasury securities of the same term. Yield maintenance premiums are designed to make investors indifferent to prepayments and to make refinancing unattractive and uneconomical to borrowers.
What does it mean when a prepayment penalty has a lockout?
Prepayment penalties will often also involve a Lockout. A Lockout disallows prepayment under any circumstances for a period of time.
What are your rates?
That depends. What kind of property is it? Is it an office building, a retail space, and apartment complex, an industrial building, etc.? Typically an office, retail center, and apartment complex (multi-family) are considered a class 1 property type and fall into our "conventional" bank type financing line. If it's an industrial building and mixed use (residential and commercial combined), that's usually considered a class 2. Class 2 properties will generally fall into our "Conventional Line" as well, but will require better cash flow then a class 1 property. Class 1 and class 2 rates will be the same 95% of the time. BUT, it ultimately comes down to the cash flow of the property that will determine the rate. We will get into cash flow and debt service coverage ratios later. A class 1 property will typically require a minimum 1.20 dscr and a class 2 a minimum of a 1.25 dscr. The financials will determine the coverage and whether or not we not we can fund this as a "Full Doc" or if we have to do a "Stated/Stated" loan.
What are your fees?
The only two fees that are the same on every loan would be the processing fee and the credit report fee. The processing fee is $1000.00 for the first borrower and $250.00 for each additional borrower plus a $50.00 credit report. The underwriting and third party report fees vary based on loan amount.
What property types do you do?
We do all property types except land (except for acquisition and development), gas stations, churches, and unique type properties (airplane hangers, night clubs, etc.). If you have questions regarding whether or not we do a property, give us a call directly.
Are you a broker or a lender?
We are a lender. Commercial Lending correspondence and residential correspondence are different. We have the authority to fully underwrite a transaction and have our "correspondent lender" table fund the transaction. This insures better pricing and eliminates the middleman. This type of relationship allows us the flexibility of funding a deal on our line (we choose not to) or their line through a table funding relationship. It's as if we are selling them the loan at close of escrow.
What are your coverage requirements?
The minimum coverage requirement for an apartment deal is a 1.20 DSCR. The minimum coverage on all other property types can range from 1.20 - 1.35 depending on the property type and the LTV.
What is a Debt Service Coverage Ratio or DSCR?
Debt Service Coverage Ratio, otherwise known as DSCR, is the number that indicates how profitable the commercial property is. For example, a DSCR ratio of 1.50 means that for every dollar you spend on the property to keep it running, you are bringing in $1.50 in income. As a standard, the lowest DSCR that most lenders will accept is 1.20.
How do I calculate Debt Service Coverage Ratio?
In order to calculate a Debt Service Coverage Ratio you will need to know what the annual mortgage payment on the property will be. You will take the annual mortgage payment on the property and divide it into your Net Operating Income. The number you end up with should have a decimal in it. For example, if your Net Operating Income is $763,456 and your annual mortgage payment is $435,000, then your DSCR is 1.755, which is typically a good DSCR.