Do I need a commercial mortgage for my 1–4 unit rental property?

Tim Milazzo
June 9, 2021

My friend Pete works in tech in New York, and he was interested in making his first real estate investment. He found a 3-unit apartment building in Brooklyn where he’d be happy to live in one unit, and rent out the other two for income. His hope is that he’d get both cash flow and property appreciation driving his investment returns.

Pete wasn’t sure if he could apply for a residential mortgage to buy this building, or if he needed to pursue a commercial mortgage. He did know that I worked in commercial real estate finance, so he gave me a call.

“Should I be using a residential mortgage or a commercial mortgage in this situation?”

I answered, “Well, it depends”

How it depends

It depends on a couple of different factors. For one, it depends on whether the property will be held in an LLC, or if Pete will own it in his own name. It depends whether Pete has any other investors who will contribute equity capital, or if it’s all his own money. It depends on a few other questions too. Sometimes, you can simply choose which type of mortgage loan to take out against the property. Here’s how to choose:

Pros of a residential mortgage

  • Full 30 year term available
  • No prepayment penalties
  • Non-recourse (you can lose the entire property, but no more)
  • Lowest rates

Cons of residential mortgage

  • Cannot use in an LLC
  • Messy if you have co-investors
  • Cannot be used for mixed-use property (like having a retail store on the ground floor)

Pros of a commercial mortgage

  • Borrower can be an LLC
  • Underwriting more directly tied to property income
  • Property can be mixed-use

Cons of a commercial mortgage

  • Loan comes due before fully paid off (“balloon payment”)
  • Somewhat higher rates and fees
  • Can include prepayment penalties
  • Can include recourse (you can lose even more money than what you put into the property)

For a more technical comparison between residential and commercial mortgages, see my colleague Huber’s recent breakdown here:

Limits of a residential mortgage

We’ve already stated that you can’t use a consumer mortgage for an LLC or a mixed-use property. But there are a few more limits to note:

  • A residential mortgage is limited to properties up to 4 units. If the property has 5 units, you’re required to apply for a commercial mortgage.
  • One person may only serve as guarantor on a maximum of 10 residential mortgage loans.

Oh, what happened with Pete? He ended up pursuing a consumer mortgage (synonymous with residential mortgage) in order to secure the lowest possible interest rate in this case.

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