Down Payments on Commercial Loans
October 14, 2019
How Much Do You Have To Put Down on a Commercial Loan?
Are you buying a property to be occupied by your business? If so, an SBA lender might only require 10% down. Are you buying an investment property, like an apartment building or an office building? Conventional lenders, like banks and credit unions, typically require 25% to 30% down. More below.
Down Payments on SBA Loans
SBA loans are designed to help business owners like you to buy business properties, such as industrial buildings or office buildings, to occupy with your businesses. In general, your business must occupy 51% of the building or reasonably expect to do so in the future. The idea is that, once your business is comfortably relocated to a permanent location, you will increase your production and hire additional wortkers.
It is possible for the experienced owner of an existing business to buy a business property with as little as 10% down, using an SBA loan. If the business is brand new, however, the SBA will not guaranty the loan with a down payment of less than 30%.
It is important to understand that the Small Business Administration ("SBA") does NOT make loans. The SBA merely guarantees a portion of your loan. Please remember the word, "portion". It becomes important in a few moments.
The loan is actually made by a bank or a finance company specializing in SBA (guaranteed) loans. Since the SBA only guarantees a portion of an SBA loan, the SBA lender has considerable loan-loss exposure. It is NOT guaranteed against all loss. For example, suppose an SBA lender makes a $1 million loan, and the SBA guarantees $870,000 of that loan. Boom! The loan goes bad, and the loss is 50% of the amount advanced. Of that $1 million loan, $130,000 is uninsured. In this case, the SBA lender would lose 50% of the uninsured $130,000 portion. Ouch! Making SBA loans is therefore NOT risk-free.
This leads to a super-important point: Every SBA lender underwrites SBA loans differently. You could easily get turned down by 10 SBA lenders, only for the 11th SBA lender to approve your loan application to buy a campground. Why? Perhaps the bank president owns a $250,000 RV and is a huge camping enthusiast.
Now back to the size of your down payment. The absolute minimum down payment to buy a business property using an SBA loan is 10% - but your particular SBA lender might come back and ask for a larger down payment. If this happens, I recommend that you apply to a different SBA lender. You can actually apply to over 200 different SBA lenders using C-Loans.com, and it takes only four minutes. C-Loans is also free!
Down Payments on Conventional Commercial Loans
A "conventional" commercial real estate loan is one that is not guaranteed by any governmental agency, such as the SBA, the USDA, or Fannie Mae. The overwhelming majority of all conventional commercial loans are made by either banks or credit unions.
If you are buying an office building or apartment building as an investment, perhaps to serve as your retirement income someday, you will need to obtain a conventional commercial loan. Conventional commercial real estate lenders typically require a minimum down payment of 25% to 30% of the purchase price.
Unfortunately, you are no longer allowed to ask the seller to carry back a second mortgage behind the bank's new first mortgage. Your down payment must be cash. Banking regulators, after the Great Recession, will not permit it.
Down Payment Strategies
If you have no down payment at all, you are out of luck. If, however, you have a sizeable down payment, but not just the full 25% to 30% of the purchase price to satisfy the bank, you might try:
- Ask the seller to carry back a second mortgage on your personal residence for the shortfall in your down payment. For example, suppose you are buying a small office building for $1 million, but you only have $220,00 to put down. The bank wants you to put down 30% of the purchase price or $300,000. You are short $80,000. The seller might be willing to carry back that $80,000 as a second mortgage on your personal resixdence at, say, 7%. That's a much higher interest rate than he could earn elsewhere.
- Ask the seller to carry back a second mortgage on another investment property that you own, like an apartment building.
- My own private money commercial lending company, Blackburne & Sons, will often allow the seller to carry back a second mortgage behind our new first mortgage.
Down Payments on USDA Business and Industries Loans
The U.S. Department of Agriculture has a commercial loan program, known as the Business and Industries ("B&I") Loan Program, for properties located in small towns. The program is very similar to the SBA loan program. Some of the poorest Americans live in small towns and rural areas. The idea behind the USDA B&I loan program is to bring manufacturers and other businesses to rural Amercia in order to create jobs.
The down payment requirement on USDA B&I Loans is similar to that of SBA loans.
Importance of Net Worth:
When applying for a conventional commercial loan from a bank, a borrower needs to make sure that the size of his commercial loan request is reasonable compared to his net worth. For example, a borrower with a net worth of just $200,000 probably is not going to qualify for a $5 million loan. The general rule is that the borrower's net worth needs to be at least as large as the size of the commercial loan he is seeking. In the parlance of commercial real estate finance (CREF), the Net-Worth-To-Loan-Size Ratio needs to be at least 1.0.
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