Commercial Mortgage

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A commercial mortgage is similar to a home mortgage except that commercial properties are pledged as collateral to secure the loan. The commercial properties are generally office buildings or other business real estates.
In addition, commercial mortgages are taken by businesses rather than individuals which are the norm in case of residential or home mortgages. These businesses may be partnerships, incorporated businesses or limited companies. Commercial mortgages are taken for acquiring land for commercial properties, expanding the facilities at an existing profit-making organization or refinancing to pay off an existing debt.

However, commercial mortgage loans have to be supplemented by careful assessment of the credit worthiness of the borrower in question which makes the loans more difficult than standard residential mortgage loans. The authenticity of the application, the type of loans the borrowers want and their purpose should be taken into consideration.

A mortgage is technically defined as a temporary or conditional pledge of one’s property to a creditor as a security for the performance of an obligation or repayment of a debt. A mortgage transfers the interest on the property and gives the creditor conditional ownership over the asset. Commercial mortgages can also be referred to as a debt instrument required to be repaid by regular loan amortizations if using investment analysis. Commercial mortgages are also non-recourse in nature, i.e. upon default of payment the lenders’ right is confined to the value of the collateral. The creditor can appropriate the property and realize its full sale proceeds; however, if the value of the property falls short of the outstanding loan balance then the creditor is required to pay out the remaining portion of the amount.

Thus commercial mortgages are generally limited to 70% or 80% of the loan-to-value ratio so that the property itself provides a sort of cushion against falling real estate prices. Non-recourse loans are forwarded for commercial mortgages associated with large capital expenditures, long loan periods and uncertain future revenue streams. Going with the characteristic of non-recourse debt, commercial mortgages are secured by commercial properties but the borrower is not held personally liable. However, commercial mortgages entail a personal obligation for the borrower and any outstanding balance is paid in full even in the case of a foreclosure.
A non-recourse debt usually enters a company's balance sheet as a liability, and the collateral is carried as an asset. Two essential features of mortgage loan amortization include the tenure or term of the loan and the regular loan amortizations. The tenure of the mortgage loan varies from five to thirty years in some cases. A balloon payment is required at the end of the loan period which leads many borrowers to refinance the loan. In terms of underwriting standards, commercial mortgages are entirely underwritten based on the attributes of the property being mortgaged rather than on the attributes of the borrower.

Because of this, many commercial mortgage providers require that commercial properties be single asset entities such as corporations or corporate bodies. This helps the lender foreclose or seize the collateral even in cases of bankruptcy pending against the borrower which is not the case for residential mortgages. Commercial mortgage lenders in the USA also require a debt servicing ratio which means the ratio of “net cash flow before debt service” (revenues less expenses excluding the mortgage payment to the debt service (mortgage payment). Interest rates on commercial mortgages can be of the FRM (Fixed Rate Mortgage) or the ARM (Adjusted Rate Mortgage) type with generally being above the residential mortgages which are not non-secure in nature. Average countrywide ARM and FRM rates have fallen hovering around 6.1% and 5.8% for 30 year and 15 year fixed rates respectively; 1 year ARM and 5/1 ARM rates are 5.43% and 5.9 % respectively. Second commercial mortgages subordinated to that of the first mortgage also carry higher interest rates.

Financial Institutions working to obtain the commercial mortgage loans in case of government sponsored enterprises such as Fannie Mae and Freddie Mac are known as agency lending institutions which have become the standard practice in the USA. Organizations such as Freddie Mac and Fannie Mae are into loan securitization (in the form of bonds) with the final servicing vested with the banks. A trend called conduit mortgages is also gaining popularity in the USA with investment banks making the loan themselves and selling the bonds (against the loan) on their own. This has been the result of investment banks becoming more vertically integrated.

Some of the top commercial mortgage providers in the USA are Arbor and Real Web Funds and Campark. The leading Indian commercial mortgage company is ICICI Lombard.