How to Compare Investment Mortgages

Mortgages on investment properties have many variables.

Mortgages on investment properties tend to be more complicated than mortgages of personal residences. Rather than having a simple 30-year amortization with a fixed interest rate, investment property mortgages can have varying terms, varying rates and a number of different variables. Luckily, once you know what to look for, comparing loans can be a relatively easy process.

Loan Amount

Commercial lenders typically set the amount of a mortgage based on two factors. The first factor is the loan to value ratio (LTV), which indicates the loan's size as a percentage of the property's assessed value. For instance, for a property that appraises for $3,000,000, a 75-percent LTV ratio would lead to a mortgage of $2,250,000. In addition to the LTV, lenders also look at a debt service coverage ratio, or DCR. The DCR is calculated by dividing the property's net operating income by the total of one year's worth of loan payments. DCRs of 1.15 to 1.3 are very common, indicating that the loan payments will need to be less than the property's income. With properties that are expensive relative to their income, the DCR may mean that the maximum loan amount is less than what the LTV ratio alone would indicate.

Interest Rate

Comparing interest rates on commercial loans is quite simple. They are always quoted on the basis of the interest rate, excluding any fees or costs of origination. While the loan at 7 percent may cost less to originate than a 6.75-percent loan, you can easily calculate what your payment will be. When looking at the interest rate, pay careful attention to the length of time for which it will be locked. If it will be an adjustable rate, look to see what the index rate is, such as LIBOR or Prime, what the spread is, which is the amount that the lender charges over the index, and what limitations, if any, there are on how the loan adjusts.

Amortization and Term

Investment property mortgages rarely have a 30-year amortization and term. An amortization period, which is the length of time over which the loan's principal payments are spread, typically falls between 15 and 30 years. Although shorter amortizations lead to higher payments, they also allow you to pay down more of the loan in a shorter period of time. Even with a long amortization, most loans only have a 10-year term, requiring a balloon payment and refinancing. If your intent is to pay down the property, you should look for a "self-liquidating" or "self-amortizing" loan, which may have periodic rate adjustments but will not require a balloon payment.

Prepayment Penalties

Most investment property mortgages carry some type of prepayment penalty. The least onerous penalties will have a fixed percentage, which may be the same for a set period or will have a declining prepayment, such as five percent in the first year, four percent in the second year, and on until after the fifth year when it has no penalty. Other loans will have a "yield maintenance" or "defeasance" prepayment where the borrower can prepay the loan at any time, but he must also pay off all of the interest that he had promised to pay over the life of the loan. Some loans even carry lockout provisions where they cannot be prepaid for any reason at all.

Recourse Requirements

Although smaller commercial loans typically do not offer this option, larger loans may be made on a non-recourse basis. This means that the lender will not have the ability to go after the borrower in the event that she defaults on the loan. Non-recourse loans are typically made by conduits and insurance companies, while loans from banks typically carry some recourse provisions.