Important Terms to Know in Commercial Lending
30/360 An interest rate accrual method in which the interest calculation assumes that all 12 months of a calendar year have 30 days and uses a 360-day year. An Actual/360 interest calculation charges interest for all 365 calendar days using a 360-day year. Therefore, borrowers pay 5 days less interest than under Actual/360.
Acceleration Clause The acceleration clause is the section in a mortgage that says if the borrower sells the property or places a second mortgage / mezzanine loan on the property that the bank can immediately demand to be paid in full.
ACH Stands for Automated Clearing House. Refers to Auto-Pay for a commercial mortgage for loan servicing.
Actual 360 An interest rate accrual method in which interest calculation charges interest for all 365 calendar days using a 360-day year. A 30/360 interest calculation assumes that all 12 months of a calendar year have 30 days and uses a 360-day year. Therefore, borrowers pay 5 days more interest than under 30/360.
Actual 365 An interest accrual method in which the annual interest will be divided by a 365 day year, and the interest for each interest period will be the interest for the actual number of days in that period. The number of days in the year for periodic calculation is usually one of three choices: 1) actual days in the year (365 or 366 for leap years), 2) always 365 days, or 3) always 360 days (based on 12 x 30-day months). Each interest basis reflects a choice for computing the number of days in the interest period and the number of days in the year in which interest is paid.
Actual/Actual An interest accrual method in which the annual interest will be divided by a 365-day year, and the interest for each interest period will be the interest for the actual number of days in that period.
Adjustable-Rate Mortgage (ARM) Mortgage for which the interest rate adjusts periodically up or down through a set index. The initial interest rate usually is lower than that for fixed-rate mortgages, but monthly payments can go up or down when the rate is adjusted. Also called a floating rate mortgage.
ADS Stands for Annual Debt Service. This is the principal and interest total payment made for the first 12 months of the loan. Typically used to calculate the DSCR by using the ADS and the NOI amount.
Agency Refers to government-sponsored entities (GSEs) such as Fannie Mae, Freddie Mac and the SBA.
Allowance Permission to prepay a certain percentage of a commercial loan every year without triggering the prepayment penalty. Typically, a loan will have an allowance of up to 20% before the prepayment penalty takes affect.
Amortization The period over which principal and interest payments are scheduled. A fully amortized loan would have a $0 balance at the end of the amortization period. A partially amortized loan will have a balance due (balloon payment) at the end of the term.
APR (Annual Percentage Rate) The effective interest rate a loan would have if one accounted for costs associated with securing the loan, such as closing costs and points. It represents the annual cost of a loan and is thus a more reliable indicator for comparing different mortgage options.
Assumable Loan A loan that can be transferred to a new owner when a property is sold. The loan terms including the amount, rate and conditions typically remain the same. The new owner also needs to qualify with the lender.
Assumption Fee A fee paid by the borrower to the lender for the paperwork and processing of records necessary to approve and document a new debtor. Applicable on an assumable loan as described above.
Bad Boys This is the same as Carve Outs and together referred to as the bad boy carve outs which is an exception provision in a non-recourse loan whereby the lender preserves the right to still seek damages for its losses. Non-recourse lenders will frequently create carve outs for fraud and toxic contamination. If you defraud the lender or fail to disclose toxic contamination, the lender will therefore still be able to come back after you for its losses.
Balloon Payment The balance due at the end of the loan term or maturity. This is common on a loan that is not fully amortized. For example, a loan with a 10-year loan term but a 25-year amortization will not have the loan completely paid down when the loan is due at the end of 10 years. That remaining balance is satisfied by a balloon payment.
Basis Point 1/100th of 1% (0.01%), typically stated as a number of basis points over an index rate. For example, a rate difference between 3.00% and 3.50% would be fifty (50) basis points. Typically used when referencing interest rates and loan points.
Blanket Loan Refers to a mortgage that covers more than one parcel of real estate owned by the mortgagor.
Borrower The individual or entity that is the primary repayor of the subject property mortgage. The borrower is responsible for making all payments and fees associated with the loan over the life of the loan. Legal mortgagor.
B-Piece Buyer The B-piece buyer is the buyer of the mortgage-backed bonds rated lower than BBB by Standard & Poors. The B-piece is often called the first loss piece, and it is by far the riskiest investment in the offering. B-piece buyers enjoy a lot of power because without someone to buy the first loss piece, the offering will fail. They therefore enjoy very high yields.
Bridge Loan Short-term mortgage financing that is in place between the termination of one loan and the beginning of another loan. Also, a form of interim loan, generally made between a short-term loan and a permanent (long term) loan, when the borrower needs to have more time before taking the long-term financing.
Bullet Also known at the Maturity or the Term. Refers to the period of time in which the debt must be paid off.
Buydown The process of paying additional points on a loan to reduce the interest rate. Buydowns can be temporary or permanent.
Cap The maximum amount that the interest rate or payment may increase for an adjustable-rate loan, regardless of index changes. An interest rate cap limits the amount the interest rate can change, while a payment cap limits the increase in monthly payment to a specific dollar amount.
Combined LTV The ratio between the loan amounts of all loans on a property and the value of the property. The ratio is commonly expressed as the percentage of value a lender is willing to finance. It differs from the loan-to-value (LTV) ratio only when the property has more than one lien.
CapEx An expense line item that includes expenses for anticipated capital expenditures required to maintain a building and future capital improvements of major building systems (e.g. HVAC, parking lot, carpets, roof, etc.). CapEx stands for Capital Expenditures but is also known as Replacement Reserves. CapEx is important to identify in an income statement because the expense in non-recurring and can affect calculations and value if not excluded.
Capital Stack The capital stack is the sum of the first mortgage plus any second mortgage plus any mezzanine loans plus any preferred equity plus the buyer's down payment or the developer's equity contribution. It is the breakdown of debt and equity on the property.
Carve-Out An exception provision in a non-recourse loan whereby the lender preserves the right to still seek damages for its losses. Non-recourse lenders will frequently create carve outs for fraud and toxic contamination. If you defraud the lender or fail to disclose toxic contamination, the lender will therefore still be able to come back after you for its losses.
Cash on Cash Also known as the cash yield. The basic formula is the annual before tax cash flow / total cash invested. This is the best way to determine the investor yield when using leverage.
Conduit The financial intermediary that sponsors the conduit between the lender(s) originating loans and the ultimate investor. The conduit makes or purchases loans from third party correspondents under standardized terms, underwriting and documents and then, when sufficient volume has been obtained, pools the loans for sale to investors in the CMBS market.
Conventional Loan A mortgage not obtained under a government insured program (such as FNMA or SBA).
Correspondent A lender, servicer or broker approved to exclusively originate a loan for another funding lender.
Credit Tenant Lease A credit tenant lease is a long-term lease on a triple-net (NNN) basis to an investment grade company - a company with a credit rating from Standard and Poor's of BBB or better. A commercial building leased on a long-term, NNN basis to CVS Pharmacy is an example of a credit tenant lease.
Crowdfunding Crowdfunding is the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet. The difference between peer-to-peer lending and crowdfunding is that P2P lending typically involves small loan amounts ($5,000 to $50,000), and just one investor lends the entire loan amount. Crowdfunding can sometimes involve much larger amounts, where lots of different investors chip in a little bit to make the loan or the equity investment.
Debt Service Coverage Ratio The Debt Service Coverage Ratio is defined as the Net Operating Income of the proposed project, as projected by the appraiser, divided by the annual principal and interest payments on the proposed takeout loan. Debt Service Coverage Ratio = Net Operating Income / Proposed Annual Payment on the Takeout Loan. The Debt Service Coverage Ratio is customarily expressed to two digits, such as 1.17 or 1.32. The Debt Service Coverage Ratio must usually exceed 1.25. In other words, the projected Net Operating Income, as determined by the independent appraiser selected by the bank, must be at least 125% of the annual principal and interest payment on the proposed takeout loan.
Debt Yield Ratio The Debt Yield Ratio is defined as the Net Operating Income (NOI) divided by the first mortgage debt (loan) amount, times 100%. For example, let's say that a commercial property has a NOI of $437,000 per year, and some conduit lender has been asked to make a new first mortgage loan in the amount of $6,000,000. Four-hundred thirty-seven thousand dollars divided by $6,000,000 is .073. Multiplied by 100% produces a Debt Yield Ratio of 7.3%. What this means is that the conduit lender would enjoy a 7.3% cash-on-cash return on its money if it foreclosed on the commercial property on Day One.
Deed of Trust An instrument used in many states in place of a mortgage. Property is transferred to a trustee by the borrower, in favor of the lender and re-conveyed upon payment in full.
Deed of Reconveyance When a borrower has paid in full on a mortgage, the lender then awards the borrower a deed of reconveyance. This document also becomes a part of public record. Also known as reconveyance deed and recon.
Default The failure to perform an obligation as agreed in a contract.
Defeasance Defeasance is the substitution of government securities for the property as collateral. A Borrower desiring to obtain a release of its property from the trust may purchase and pledge to the trust a collection of government securities that are specifically selected to generate sufficient cash to make all monthly payments due on the loan through and including any balloon payment due on the maturity date. Defeasance is not prepayment. Technically the note remains outstanding but is repaid from cash flow from the government securities purchased rather than through cash flow generated by a property. The property is released to the Borrower free from the mortgage lien.
Deficiency Judgement A court order to pay the balance owed on a loan if the proceeds from the sale of the security are insufficient to pay off the loan. Deficiency judgments are not allowed in all states.
Delinquency A loan payment that is overdue but within the period allowed before actual default is declared.
Due Diligence The process of investigation, performed by investors, into the details of a potential investment, such as an examination of operations and management and the verification of material facts.
Due-on-Sale Clause A provision in a mortgage or deed of trust that allows the lender to demand immediate payment of the balance of the mortgage if the borrower sells the home.
End Loan A permanent loan that is used specifically to pay off a construction loan. End loans are more commonly known as takeout loans. All takeout loans are permanent loans, but not all permanent loans are takeout loans. For example, a refinance used to pull equity out of a property would be a permanent loan but not a takeout loan.
Equity The difference between the property value less the total debt liens on the property. This is the net value of the property to the owner.
Exit Fee A fee owed to a commercial real estate lender when a loan is paid off. This is usually presented as a point fee and is more common on bridge and private loans. An origination fee or loan point usually collected upfront at the origination of the loan might be pushed to the back end or exit when the loan is paid off.
Foreclosure The process by which a lender takes back a property on which the mortgagee had defaulted. A servicer may take over a property from a borrower on behalf of a lender. A property usually goes into the process of foreclosure if payments are no more than 90 days past due.
Forward Commitment A written promise from a lender to provide a loan at a future time.
Good Faith Deposit The upfront deposit from the Borrower to the Lender to begin the loan underwriting process. The amount is determined by the Lender and usually covers the property reports and an overage. This is usually separate from a Rate Lock Deposit.
Guarantor Also known as a sponsor. A guarantor is someone who signs personally for a commercial loan. Usually Borrowers that are entities will have their managers and majority partners sign as Guarantors for the loan.
GSE Stands for government-sponsored entity and includes lenders such as Fannie Mae, Freddie Mac and the SBA. Also more commonly referred to as Agency lenders.
Hard Money Usually short-term loans designed for properties that do not cash flow, situations requiring quick closings, or borrowers or transactions that cannot qualify for conventional financing.
Hybrid Loan A part fixed rate loan and part adjustable-rate loan. Most commercial real estate loans are hybrid loans and have a fixed rate for the first portion of the loan, followed by a period of adjustable rate.
Impounds Impounds are additional mortgage payment collections above and beyond the principal and interest payment collections. A lender may “impound” for property taxes, insurance, tenant improvements, leasing commissions or deferred maintenance among other things.
Interest Accrual Method The method by which interest is calculated through the loan term; options include Actual 360, Annual 365, 30/360, and Actual/Actual.
Interim Financials This refers to the most recent year of business financials that are not reported yet on a tax return.
Index A published interest rate, such as the Prime Rate, LIBOR, Treasury Bill / Treasury Note rate, 11th District COFI, etc. Lenders use indexes to establish interest rates charged on mortgages or to compare investment returns. A final note rate typically includes an Index Yield plus a Spread.
Interest Rate The sum charged for borrowing money, expressed as a percentage.
Investment Grade An investment is considered investment grade if it is rated BBB or better by Standard & Poors.
Junior Debt A mortgage that is subordinate to the claims of a prior lien or mortgage; a second mortgage.
Leverage Using someone else's money to purchase a property. Refers to the ability to use the investment as collateral for a loan.
Lien A legal claim or attachment against property as security for payment of an obligation.
LIBOR The short-term rate at which banks will lend to each other in London. Commonly used as a benchmark for adjustable-rate loans. Stands for London Inter Bank Offering Rate. This is a common index used for commercial real estate loans.
Loan Documents Documents prepared by a lender in conjunction with granting the loan to the borrower; may include a promissory note, deed of trust, and required loan disclosure documentation.
Loan-to-Cost Ratio The most important ratio in commercial construction loan underwriting is, by far, the Loan-To-Cost Ratio. The Loan-to-Cost Ratio is the construction loan amount divided by the total cost of the project, the result being multiplied by 100%. Loan-To-Cost Ratio = (Construction Loan Amount / Total Project Cost) x 100%.
Lockbox Provision The trustee is given control over the gross revenues of the underlying properties in a CMBS. Property owners only have claim to cash flows net of expenses. Expenses include debt service, taxes, insurance, and other operating expenses. The lender ensures they are repaid first before owners get their distributions.
Lock Out Clause A provision in a mortgage or deed of trust that prohibits early prepayments. This can vary lender to lender, but in the case where it is considered it is usually only for the first few years of the loan.
LOI Stands for Letter of Interest. Also referred to as a Term Sheet or Letter of Expression among others. An LOI is a summary of loan terms that a lender is proposing to the Borrower before the underwriting process commences.
LTV The Loan-to-Value Ratio is defined as the Loan Amount / Value. A $5,000,000 loan request on a $10,000,000 property value would be a 50% LTV.
Maturity Refers to the period in which the debt must be paid off. Also known as a loan term or bullet.
Margin The amount that is added to an index rate to determine the total interest rate for an adjustable-rate mortgage. The margin may also be known as the spread.
Mezzanine Loan A mezzanine loan is similar to second mortgages, except a mezzanine loan is secured by the stock of the corporation that owns the property, as opposed to the real estate. Because stock is personal property and not real property, a lender can foreclose on a mezzanine loan faster than the real estate. It is a loan on equity instead of debt like a commercial mortgage.
Mini-Perm Mini-perms are short term commercial first mortgages, typically made by commercial banks at interest rates that are much lower than those offered by bridge lenders. Mini perms are most often created as part of a construction loan request.
Mortgagee The lender in a mortgage transaction.
Mortgagor The borrower in a mortgage transaction who pledges property as a security for a debt.
Mortgage Broker the entity that acts as a go-between between an investor/landlord and mortgage lender, handling the loan origination and the processing of the loan. A broker does not make direct loans to buyers but works to find the best deal and finally collects fees as part of the mortgage process.
Multifamily This refers to a residential property that has 5-units or more. When a property has 5 residential units and above it is considered and underwritten as a commercial property. A property with 1-4 units is considered residential property.
NOI Stands for Net Operating Income. The total income less operating expenses, adjustments, etc., but before mortgage payments, and non-recurring expenses such as capital improvements, tenant improvements and leasing commissions.
Non-Recourse A mortgage in which the lender will not pursue personal liability against the borrower. The lender's security is the real estate being financed. Usually subject to standard carveouts including fraud and misrepresentation.
Notice of Default To initiate a non-judicial foreclosure proceeding involving a public sale of the real property securing the deed of trust, the trustee under the deed of trust records a Notice of Default and Election to Sell the real property collateral in the public records.
Note This refers to the Promissory Note which is part of the loan documents to borrowers and outlines the rates and terms of the commercial loan.
Origination Fee A fee calculated as a small percentage of the value of the loan, charged by a mortgage lender or broker for processing the loan. Usually calculated in loan points. A 1% origination fee (1 point) of a $5,000,000 loan would be $50,000.
Owner-User This refers to a commercial real estate property that is both owned by the Borrower and whose tenant is owned by the Borrower. Owner-user properties are business real estate for business owners.
PAR No loan origination points charged. This sometimes can be done in exchange for a higher interest rate.
Partial Recourse A combination of recourse and non-recourse conditions in a loan.
Permanent Loan A permanent loan is a first mortgage on a commercial property that has a common commercial loan structure usually of a 5-year fixed rate or longer and a 25-year amortization or longer. Usually termed to distinguish from a short-term loan such as a bridge loan or construction loan.
PFS Personal Financial Statement. This form provides a summary of a Borrower’s assets and liabilities.
Phase I An assessment and report prepared by a professional environmental consultant which reviews the property - both land and improvements - to ascertain the presence or potential presence of environmental hazards at the property such as underground water contamination, PCB’s, abandoned disposal of paints and other chemicals, asbestos and a wide range of other potentially damaging materials. This Phase I Environmental Site Assessment ("ESA") provides a review and makes a recommendation as to whether further investigation is warranted (a Phase II Environmental Site Assessment). This latter report would confirm or disavow the presence of an environmental hazard and, should one be found, will recommend additional review and/or mitigation efforts that should be undertaken.
PITI Stands for principal, interest, taxes and insurance. This would be the four components of a mortgage payment if it was an amortized loan with impounds.
Points Points are a one-time charge assessed at closing by the lender or broker for loan origination. One point equals 100 basis points, or 1% of the loan. Referred to as a "par loan" if no points are charged by the lender.
Portfolio Loan A commercial real estate loan that the lender has no intention of ever selling off. The loan would stay within the real estate portfolio of the lender.
Prepayment Penalty A fee penalty charged to a borrower who makes a prepayment on a commercial loan both partial or in full. The three most common forms of prepayment penalty are "yield maintenance," "defeasance," and "stepdown” or “declining percentage”.
Prime Rate The interest rate that commercial banks charge their most creditworthy borrowers, such as large corporations. This is a popular index for commercial real estate loans most commonly SBA loans.
Principal The amount of debt, not including interest, left on a loan. Principal is the face amount of a loan.
Promissory Note Also known shorthand as the Note. It is part of the loan documents to borrowers and outlines the rates and terms of the commercial loan.
PTA Prior to Approval. Refers to a loan condition and when it is required to be addressed.
PTD Prior to Documents. Refers to a loan condition and when it is required to be addressed.
PTF Prior to Funding. Refers to a loan condition and when it is required to be addressed.
Recourse A type of mortgage loan in which the lender's remedies in the event of borrower default are unlimited, extending beyond the property to the borrower's personal assets.
REIT A real estate investment trust, sort of like a mutual fund that buys and operates commercial buildings. REIT's are exempt from Federal income taxes, as long as they pass 90% of their earnings through to their shareholders.
Rent Roll A Rent Roll is a tenancy list that summarized the leases. A Rent Roll may include unit numbers, tenant names, lease start, lease end, current rent charge, market rent change, and any special notes or considerations that would be on a lease abstract.
Securitization The process of turning a pool of mortgages into bonds that can easily be traded in the organized securities market.
Senior Loan This is a commercial loan that is in first lien position. The primary loan on a property above and secondary financing.
Servicer Institution acting for the benefit of the certificate holders in the administration and servicing of mortgage loans in the CMBS. Functions include reporting to the Trustee, collecting payments from borrowers, advancing funds for delinquent loans, negotiating workouts or restructures (as permitted by the PSA), taking defaulted loans through the foreclosure process, and liquidating defaulted loans and REO.
Single Asset Entity This is a commercial real estate ownership entity whose only asset is the subject property and whose only debt is the subject property mortgage. No other assets or liabilities encumber the entity.
Small Balance A term that usually refers to loans that are under $5,000,000. However, it is a term used loosely and may be a different amount considered depending on the lender or person you are speaking to.
Sponsor Also known as the Guarantor. A sponsor is someone who signs personally for a commercial loan. Usually Borrowers that are entities will have their managers and majority partners sign as Sponsors for the loan.
Spread Also known as the Margin. The amount that is added to an index rate to determine the total interest rate for an adjustable-rate mortgage.
Sizing Refers to a lender or broker analyzing the 3 most common loan calculations: the Loan-to-Value Ratio, Debt Service Coverage Ratio, and Debt Yield Ratio.
SREO Schedule of Real Estate. A form that provides details of the real estate owned by a Guarantor.
Stabilized Refers to a commercial property being 100% occupied at or near market rent levels. Stabilized means the property has reached its potential and is collecting the likely maximum potential rent.
Stepdown Refers to a stepdown prepayment penalty or a declining percentage prepayment penalty. The prepayment penalty for the loan declines or “steps down” every year that passes into the life of the loan. A 5-4-3-2-1-0% structure would start with the first year penalty at 5% and decline until the penalty expires to 0% in the fifth year.
Subordination Clause A clause in which the holder of a mortgage permits a subsequent mortgage to take priority. Subordination is the act of yielding priority. This clause provides that if a prior mortgage is paid off or renewed, the junior mortgage will continue in its subordinate position and will not automatically become a higher or first mortgage.
SWAP Refers to a SWAP contract interest rate structure explained in more detail in this guide.
Takeout Loan A takeout loan refers to the permanent loan that pays off a construction loan. A developer is “taking out” the construction loan with a long-term loan.
Term The length of a loan. Also known as Maturity or the Bullet.
Third Party Reports Reports from third part professionals such as appraisals, environmental reports, title reports, structural engineering reports, surveys, etc.
TI/LC Stands for reserves for tenant improvement and leasing commission replacement reserves (TILC). Tenant Improvements refers to the expense to physically improve the property to attract new tenants to new or vacated space which may include new improvements or remodeling. May be paid by tenant, lessor, or both. Typically, tenants are provided with a market rate TI allowance ($/sq. ft.) that the owner will contribute towards improvements. The tenant must pay for amounts above the TI allowance desired by the tenant. A Leasing Commission is an amount, usually a percentage of the total lease transaction, earned by a real estate broker or leasing agent for his services. Combined, the annual projected cost of tenant improvements and leasing commissions (TILC's) are deducted from the net operating income prior to determining the net cash flow available for debt service coverage.
Trailing 12 The income & expense of a commercial property from only the 12 months preceding the month of the analysis. This would arguably be the most accurate reflection of the property’s operations as it the most recent annual data available.
Tranche A tranche is slice of the yield of a mortgage-backed security. There are always various (6-12) tranches in a securitized offering. The buyers (investors) of the lower tranches enjoy lower yields, but they enjoy priority of payment if problems develop within the pool of underlying loans.
Underwriting The process of a Lender of deciding whether to make a loan to the Borrower and at what final terms.
Yield Maintenance A prepayment premium that allows lenders to attain the same yield as if the borrower made all scheduled mortgage payments until maturity. The lender collects a lump sum from the borrower based on a formula that considers the present value of the difference between the prepaid loan's interest rate and current rates with a similar maturity date.
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