One may think that underwriting a commercial loan and a residential loan are very similar, they would be incorrect.  While both are loans secured against real estate, that is about where the similarity ends.

As stated in a previous blog a commercial property is defined as one that generates cash flow to determine if a property debt services, while a residential loan more than likely is secured by a primary residence or second home, so cash flow does not usually apply. Commercial underwriters underwrite to cashflow, the debt service of a property and the “global” cash flow which not only the subject property, but also includes the individual’s personal income and debts.  For example for every $1 a bank lends, they want to see the individual earns $1.25 to $1.30 in income.  A residential underwriter underwrites to Debt-to-Income. They look at the total debts and divide it by the total income.  Again, the difference is in the details.

Another main difference you’ll see is in the appraisal. A residential appraisal use comparable properties to determine a property’s value. The appraiser looks at bed room and bathroom count, along with lot size and condition of the property and takes a market approach for the value.  A commercial appraisal is more expensive because not only are they taking into account the previous criteria, they also look at the cost approach, how much it would cost if they had to rebuild brick by brick and the income approach meaning they’re looking at the local market rent in the similar properties. Keep in mind, the more in-depth the report, the higher the cost.

The majority of residential loans are underwritten using Fannie Mae and Freddie Mac guidelines.  Their loans are backed by the government and provide uniformity in underwriting guidelines. Most commercial loans however are underwritten using individuals banks guidelines and not backed by the government.  This is why you see different banks specializing in lending to different kinds of properties and have different terms and programs.

 Understanding the difference between the lending criteria will help you to better prepare for the loan process.