Commercial vs. Residential Loans: Which Is Better for Investors?

So you’re ready to dive into the world of real estate investing and want to start exploring the lay of the financing land. Team Parker is here to help by shedding light on two common options – commercial loans and residential ones. That way, you can better determine the right fit for your financial situation and the type of property you’d like to invest in.

Commercial Loans

What is a commercial loan? It’s a debt-based financing option primarily used to buy property that will be used for a business purpose. A common misconception? They’re the only type of loan that can be used for investment occupancy. In fact, many primary home loans, second home occupancy ones, and investment occupancy loans can be residential in nature, but more on that later!

Important Things to Note

• Commercial loans are typically originated by specialty lenders or banks themselves
• Because they look at the potential income of the property and not the borrower’s debt-to-income ratio, they generally have high interest rates, high down payments, and short loan terms
• While they can be obtained for dwelling properties with 1-4 units or more, they’re typically used for dwelling purchases of at least five units
• They are popular options for buyers purchasing a property in the name of an LLC
• It’s rare to find a commercial loan with a 30-year term; 15 years is more common
• If originated in your name, a commercial loan WILL count against your debt-to-income ratio and will also be included when it comes to the finance rule that states you cannot have more than 10 properties at a time.

Who are commercial loans best suited for?

Generally, commercial loans are great options for real estate investors who are looking to purchase a property in the name of an LLC. While this type of purchase is possible with a residential loan, it’s considered to be slightly more risky or complicated.

It is possible to use a commercial loan for a residential property. Why would you do so? Since commercial loan approval is based on the property, not the buyer’s personal finances, they can be a good fit for buyers without W2 income or history who plan to live on-site and rent out the other units.

Along with that, commercial loans are good options if you’re interested in buying a dwelling property with five or more units. Residential loans are only for dwellings with four or fewer units.

Lastly, this type of investment loan may be a good fit for you if you’ve reached your 10 residential loan limit and work with an LLC that will purchase the property in the LLC’s name.

Residential Loans

Now, let’s turn our attention to another popular option – residential loans.

What is a residential loan? It’s one that is used to purchase a property you plan to live on. These types of mortgages cover a range of properties, including multi-unit dwellings. That’s right – it’s possible to purchase, say, a 3-unit dwelling with a residential loan, but only if you plan on living in one of those three units. The other two, you can rent out!

They’re great options for a range of investors, including primary home buyers, second home occupancy, and investment occupancy properties.

Loan Highlights

• Many mortgage brokers offer residential loans, which means you may have quite a few lenders to choose from
• These loans come in all shapes and sizes; down payments, loan terms, and even interest rates can be unique to the borrower
• Can’t be used to purchase a multi-unit property with five or more units
• Since they are originated in your name, they will count against your debt-to-income ratio and will be included when it comes to the maximum number of financed properties you can have in your name at once (the current limit is 10)

Residential Loan Occupancy Types

For properties with four units or less, there are three occupancy lending types, which are:

1. Primary home. The property you intend to primarily reside in.

2. Second/vacation home. A residence you intend to occupy “some portion of the year.”

3. Investment occupancy. Here, an investment occupancy residential loan means you’re purchasing a residential property with the intention of earning income from it. For example, purchasing a four-unit dwelling, intending to live in one, and renting the other three out. Because the loan is residential, your personal debt-to-income ratio is taken into account.

This third loan type can be applied to short-, mid-, and long-term rentals and can typically be obtained with 15-25% down. For more on those, visit our STR vs. MTR vs. LTR blog.

Who are residential loans best suited for?

The great thing about residential loans is that they fit a variety of situations, properties, and buyers. From a first home purchase to a vacation home or investment occupancy, these loans can help you build your real estate portfolio. Provided the property you’re interested in purchasing doesn’t have five dwelling units, a residential loan may be the right fit for you.

Because every real estate investor and buying situation is unique, we encourage you to schedule a complimentary consultation to learn more about residential loans and see if they’re the wealth-building move for you.

Direct Comparison

Now that you know a little about each type of lending solution, let’s do a quick head-to-head comparison.

Property

Commercial Loan

Can be used to purchase many types of properties that serve a business purpose.

Residential Loan

Can also be used for many property types, as long as you intend to live in it some portion of the year. However, when it comes to properties with multiple dwellings, there must be four or fewer units.

Term

Commercial Loan

Typically 15 years.

Residential Loan

15-year and 30-year terms are common, typically with no prepayment penalties or balloons.

Qualification

Commercial Loan

Looks at the potential income of the property, not the financial situation of the borrower.

Residential Loan

Based on the borrower’s personal financial situation, including their debt-to-income ratio.

Down Payment

Commercial Loan

Tend to be high on average.

Residential Loan

Varies based on the situation but can range anywhere from 3% to 20%.

The 10 Max Financed Property Rule

Commercial Loan

If originated in your name, a commercial loan will be included in your financed property count.

As an additional note, it will also be included in your debt-to-income ratio.

Residential Loan

A residential loan in your name will be included in your financed property count, as well as your debt-to-income ratio.

Did you know that if you’re married, you can finance up to 10 properties at a time, and your partner can as well? That means you’d be able to have 20 properties between the two of you, for both commercial loans in your name and residential ones.

Secure Your Investment Loan With Help From Team Parker

Now that you know more about the difference between commercial loans and residential loans, why not learn more about which is right for you? Schedule a free consultation with our lending experts to discuss your opportunities and start building wealth today!