The Fundamental Difference
Residential lending focuses on the borrower's ability to repay based on personal income.
Commercial lending focuses on the property's ability to generate income to service the debt.
This distinction drives virtually every other difference between the two.
Side-by-Side Comparison
| Factor | Residential | Commercial |
|---|---|---|
| Primary focus | Borrower income | Property income |
| Key ratio | DTI (Debt-to-Income) | DSCR (Debt Service Coverage) |
| Loan terms | 15-30 year fixed | 5-10 year terms, 25-30 year amort |
| Rates | Lower, standardized | Higher, more variable |
| Down payment | 3-20% | 20-35% |
| Qualification | Standardized (FNMA/FHLMC) | Lender-specific |
| Closing time | 30-45 days | 45-90 days |
| Documentation | Standardized | Extensive, deal-specific |
| Prepayment | Usually flexible | Often restricted |
| Recourse | Full recourse | Often non-recourse available |
Underwriting Differences
Residential Underwriting
- DTI ratio (typically max 43-50%)
- Credit score heavily weighted
- Employment/income verification
- Standardized automated underwriting
- Appraisal focused on comparable sales
Commercial Underwriting
- DSCR ratio (typically min 1.20-1.25x)
- Property NOI analysis
- Rent roll and lease review
- Borrower net worth and liquidity
- Experience evaluation
- Appraisal includes income approach
- Environmental assessment required
Loan Structure Differences
Terms and Amortization
Residential:
- 15 or 30-year fully amortizing
- Rate stays fixed for entire term
Commercial:
- 5, 7, or 10-year terms typical
- 25-30 year amortization
- Balloon payment at maturity
- Must refinance or pay off at term end
Interest Rates
Residential:
- Tied to conforming loan standards
- Relatively uniform pricing
- Points can buy down rate
Commercial:
- Varies significantly by loan type
- Spread over index (Treasury, SOFR)
- Negotiable based on deal strength
Prepayment
Residential:
- Most loans have no prepayment penalty
- Can refinance freely
Commercial:
- Often have prepayment penalties
- Yield maintenance, defeasance, or step-down
- Important to understand before signing
Documentation Differences
Residential Requirements
- Pay stubs (30 days)
- W-2s (2 years)
- Tax returns (2 years)
- Bank statements (2 months)
- Credit report
Commercial Requirements
- Property rent roll
- Operating statements (2-3 years)
- Borrower financial statements
- Tax returns (personal and entity)
- Entity documents
- Environmental reports
- Property inspections
- Lease abstracts
Recourse vs. Non-Recourse
Residential: Almost always full recourse—lender can pursue your personal assets if you default.
Commercial: Non-recourse options available—lender's recovery limited to the property (with carve-outs for "bad boy" acts like fraud).
Non-recourse is a significant advantage of commercial lending for qualifying borrowers.
The 5-Unit Threshold
Properties are classified based on unit count:
- 1-4 units: Residential financing (even if investment property)
- 5+ units: Commercial financing
This threshold matters because:
- Different regulatory framework
- Different underwriting standards
- Different loan products available
Why Commercial Rates Are Higher
- Smaller market: Less standardization and liquidity
- Higher risk: Business properties can lose tenants
- Complex underwriting: More lender resources required
- Less government support: No equivalent of Fannie/Freddie for most commercial
- Shorter terms: Refinance risk priced in
Making the Transition
If you're moving from residential to commercial investing:
Start Here
- Learn the vocabulary (DSCR, NOI, cap rate, debt yield)
- Understand different loan products available
- Build relationships with commercial lenders/brokers
- Start with simpler properties (small multifamily)
- Assemble your team (attorney, CPA, property manager)
Common Mistakes
- Assuming residential qualification standards apply
- Underestimating documentation requirements
- Not budgeting for third-party reports
- Ignoring prepayment penalties
- Not understanding balloon payment implications
Get Expert Guidance
Transitioning to commercial real estate financing doesn't have to be overwhelming. Our team can help you understand your options and find the right loan product for your deal.
Contact us for a free consultation.
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