When preparing to apply for any loan, it’s important to have at least a general understanding of the vocabulary that you’ll come across while reviewing the loan’s terms. That way, you’ll know exactly what you’re signing up for and what’s expected of you, and you can let your lender know right away if you aren’t happy with anything in the loan agreement before you sign on the dotted line.
Even if you’ve been through the process of getting other types of loans, when it comes to commercial loans, such as those that you might need for a construction project or for a fix-and-flip venture, you might end up coming across some new terms. Or you might want to make sure that you understand the terms’ usage in these types of loans. That’s why we’ve compiled a short commercial loan vocabulary list below. Feel free to use this list to take some of the guesswork out of any commercial loan that you’re thinking about getting. Not all loans will have all of these clauses. This is simply terms to consider and learn about as a real estate investor, particularly in the commercial arena.
Clauses
- Acceleration clause– a section stating the bank can demand payment in full if the borrower ends up putting a mezzanine loan on the property, without the approval of the lender.
- Lockout clause – this prohibits early prepayment
Loans
- Buy-to-rent loan – allows an investor to purchase a residential property and rent it out long-term
- Major loan – a permanent loan, commercial construction loan, or bridge loan that’s greater than $5 million
- Mezzanine loan– this is similar to a second mortgage, but rather than being secured by the real estate, it’s secured by the owner corporation’s stock
- Mini-perm– a short-term commercial first mortgage
- Open-ended construction loan– a loan for commercial construction that doesn’t require a forward takeout commitment (a.k.a. uncovered construction loan)
- Permanent loan – a first mortgage for a commercial property
- Takeout loan– a permanent loan to pay off a construction loan
Ratios
- Debt service cover ratio– calculated by taking the net operating income and dividing it by the proposed annual payment on a takeout loan
- Debt yield ratio – the net operating income divided by the loan amount, multiplied by 100%
- Loan-to-cost ratio– the amount of a construction loan divided by the total project cost, multiplied by 100%
- Loan-to-value ratio– the fully-disbursed construction loan amount divided by the value of the completed property, multiplied by 100%
- Net-worth-to-loan-size ratio – the net worth of the developer divided by the amount of the construction loan
- New-money-to-old-money ratio – the size of a proposed second mortgage, divided by the size of the first mortgage, multiplied by 100% (typically needs to be greater than 33%)
- Profit ratio– the projected profit (calculated as the value of the property after it’s completed, minus the total cost of the project), divided by the total cost, multiplied by 100%
Reserves, Fees, Costs
- Contingency reserve– the portion of a construction loan budget that’s used for cost overruns
- Exit fee– owed to the lender once a loan is paid off
- Hard costs– the costs in a construction loan budget that are associated with making visible improvements to a property, such as carpentry, landscaping, roofing, electrical, concrete, etc.
- Soft costs – construction costs that aren’t visible, such as engineering fees, toxic report fees, architect fees, government fees, permit costs, appraisal fees, etc.
- Total cost– the sum of hard and soft costs, along with the cost of land, plus a contingency reserve that’s roughly 5% of the soft and hard costs
Other Interesting Terms
- Black hair– a weakness or flaw in an application for a commercial loan
- Core asset – commercial investment property that can continue making money, thanks to reliable tenants (e.g. a Class A office building, a retail center, or an R&D building)
- Door – an apartment unit
- Floater – an adjustable rate commercial loan (typically, the term is five years)
- Key – a hotel room, particularly in a hotel that has suites
- See-through building – a commercial building that’s newly constructed and doesn’t have any tenants or tenant improvements
Navigate the Confusing World of Commercial Loan Vocabulary with a Pro!
Deciphering the ins and outs of commercial loans on your own can be extremely difficult. But with help from a professional lender, like those at Merchants Mortgage, you can rest assured that you’re making the best deal for your next big real estate project.
Remember, the right loan can help you get your project off the ground, as well as help ensure your financial security. So contact us today if you have questions about commercial loans, or if you’re ready to sort through various loan options, whether you need a fix-and-flip loan, a construction loan, or a fix-and-hold loan.