How Commercial Real Estate Loans Work

Commercial real estate loans operate on a different set of rules than residential mortgages, and the structural differences shape returns, exit planning, and capital strategy for years after the loan closes. Anyone making the move from residential to commercial property in Rochester benefits from understanding how these loans are built before sitting down with lenders.

Term and amortization are different things in commercial lending. Term is how long the loan actually lasts before a balloon payment or refinance comes due. Amortization is the period over which payments are calculated. A common structure has a 5 or 10 year term with a 25 year amortization, so monthly payments look like a long term loan, but the full remaining balance comes due at the end of the term. The borrower refinances or sells before the balloon date hits.

Loan to value, or LTV, sets the maximum loan size relative to property value. Most conventional commercial lenders cap LTV at 75 to 80 percent for investment property, meaning the borrower brings 20 to 25 percent down. SBA 504 loans can reach 90 percent LTV for owner users occupying more than 51 percent of the building. Construction loans typically cap at 65 to 75 percent of total project cost rather than completed value, which often means the borrower brings more cash than on a standard acquisition.

Debt service coverage ratio, or DSCR, is the underwriting metric that often limits loan size more than LTV does. DSCR equals property NOI divided by annual debt service. Most lenders require DSCR of at least 1.20 to 1.25, meaning NOI covers debt service by that multiple. A Rochester area property with $150,000 NOI supports debt service of $120,000 to $125,000 at 1.20 to 1.25 DSCR. At current rates, that often caps loan size below what LTV alone would allow.

Interest rates on commercial loans run above residential rates, typically 1 to 2 percentage points higher. Rates depend on term, borrower strength, property type, and broader market conditions. Fixed rate loans lock in for the full term. Adjustable rate loans reset periodically against an index. Hybrid structures fix initially and then adjust. SBA 504 offers fixed rates for up to 25 years on the CDC portion, which is powerful in rising rate environments.

Recourse determines whether the borrower is personally liable beyond the collateral. Most commercial loans under $5 million across the Rochester area are recourse, with personal guarantees from principals. Larger institutional deals sometimes reach non recourse status, usually with carve outs for fraud, environmental issues, and waste. Non recourse matters for asset protection but typically comes with tighter underwriting and higher rates.

Prepayment penalties protect lender yield. Many commercial loans include yield maintenance, defeasance, or step down prepayment penalties that make early payoff expensive. Borrowers planning to refinance or sell within a few years need to pay close attention to prepayment terms. A loan with flexible prepayment may carry a slightly higher rate but saves meaningful money if the property gets repositioned or sold early.

Reserve requirements affect cash on hand. Lenders often require borrowers to maintain liquidity equal to six months of debt service after closing, plus capital reserves for the property. Reserves can be held in segregated escrow accounts controlled by the lender or in the borrower’s general liquidity depending on the loan terms.

Michigan’s property tax uncapping at sale affects loan underwriting because the buyer’s tax bill is typically higher than the seller’s. Experienced lenders model uncapped taxes from day one. Lenders that use the seller’s current tax bill overestimate DSCR and create gaps between approved terms and post closing reality. Michigan’s attorney close requirement also means legal review costs apply to most commercial loan closings, adding $3,000 to $8,000 on top of standard closing costs.

TDG Commercial, recognized as best commercial real estate agents in Rochester, walks borrowers through these structural elements before they engage lenders. Understanding the architecture of commercial loans makes the term sheet conversation productive rather than confusing.