Everyone saves for a rainy day. Unfortunately, sometimes it’s not enough. When an emergency comes calling, it pays to have a valuable asset to fall back on. If you find yourself in sudden need of financial aid and own a commercial property, you can avail a loan against the same.
However, before you apply for a loan against commercial property, make sure that you have done your due diligence.
The Loan Amount
The amount that you can borrow against your commercial property will vary, sometimes substantially, from lender to lender. It depends upon multiple factors, which may also be different across lenders.
Conventionally, financial institutions offer anywhere between 50-70 percent of your property value as a loan. So, if your requirement exceeds that amount, you may want to talk to more than one lender before making a choice. Remember to not avail a loan amount that is more than what you need though.
Condition of the Property
The value of your property will depend upon its condition. The factors that determine the condition of your property include its age, the amenities available, the size, the reputation of the builder and its location.
Some lenders require your commercial property to occupy a requisite quota or percentage of the total building below which you will not qualify for the loan.
Lenders also take into consideration the goodwill and reputation of the developer who built the property. A new commercial property will always fetch more attractive terms and conditions of the loan than an old property.
It may prove to be daunting to avail a loan against commercial propertythat is old or dilapidated.
Documentation
When availing a loan against commercial property, lenders tend to scrutinise more than other loans. While the list of documents varies from lender to lender, most ask for the following –
- Tax returns – number of years may vary depending upon your lender of choice
- Financial reports, records and books
- Off-Balance sheet financing like leases
- The cash-flow projection for the loan life cycle
- Credit reports of the partners/owners and the business
- Certification, either as a limited liability entity or a corporation
- Property appraisal by a third party
In some cases, the lender may even ask for proof of citizenship of the owners or partners.
Rate of Interest
Fortunately, since a loan against commercial property is a secured loan, the interest rate will never be as high as an unsecured loan such as an education loan or a personal loan. However, interest rates vary from lender to lender.
It is prudent to speak to multiple lenders and assess their interest rates before choosing where to apply for your loan.
Loan to Value Ratio
The loan to value ratio or LTV is the ratio of the loan amount to the value of the property. Most financial institutions offer around 70-80 percent of your residential property value as a loan. If your property is commercial, the LTV comes down to between 50-55 percent.
The inherent risk factors that accompany all businesses are the reasons LTV for loans against commercial property is less when compared to residential property.
Debt-Service Coverage Ratio
The debt service coverage ratio (DSCR) compares a property’s annual mortgage debt service (including interest and principal) to its annual net operating income (NOI). It calculates the ability of the property to service its debt.
Lenders use this ratio to determine the cash flow generated by the business to approve the loan ticket size. If the DSCR is less than 1, it denotes a negative cash flow.
Typically, lenders look for DSCR that is 1.25 or above when sanctioning loans against commercial property.
Foreclosure
Many lenders have built-in mechanisms into their loan agreements to realise an expected yield on their loan. As such, they exact a penalty on foreclosure of a loan.
If you anticipate that you will be able to repay the loan before term, you should read the terms and conditions within the agreement very closely. This will help avoid any adverse clauses that may hurt your chances of becoming debt-free sooner than expected.
No Tax Benefits
Unlike a home or an education loan, when you avail a loan against commercial property, you do not enjoy any tax benefits. This means that you will have to pay tax on the amount that you will be using for loan repayment.
This is one of the more potent arguments in favour of education or home loan. Although these loans attract higher rates of interest, they also offer tax exemptions.
Processing Fees and Other Charges
Often, to attract prospective borrowers, various agents cite “no hidden costs” when processing a loan against commercial property. However, besides the processing fees, financial institutions often attach other charges to a loan such as legal, registration and assessing fees.
It is wise to enquire about these before asking for the final quote from your lender.
You can use the loan against your commercial property to meet a wide range of unforeseen expenses. Make sure that you keep the aforementioned pointers in mind before applying to avoid any pitfalls later on.
