A commercial mortgage is a loan used to buy or refinance income-producing real estate, and it works very differently from a home loan. The borrower is almost always a business entity rather than a person, approval turns on the property’s rental income more than on the owner’s paycheck, and the loan usually ends in a balloon payment that forces a refinance or sale within five to ten years. Properties financed this way run from office buildings and retail centers to industrial warehouses and apartment complexes with five or more units. Once you understand how lenders underwrite the deal, how the payment structure is built, and where the real costs sit, the product stops looking mysterious.
Who Borrows and What Qualifies
The borrower on a commercial mortgage is typically an LLC, partnership, or corporation formed to own the property, with the principals signing personal guarantees behind it. The collateral is income-producing real estate: multifamily buildings of five units or more, office, retail, industrial, hospitality, and specialty properties like self-storage. Owner-occupied commercial buildings (where a business buys the space it operates out of) are financed too, often through SBA programs discussed below.
How Lenders Decide to Approve You
The most important number in a commercial mortgage application is the Debt Service Coverage Ratio. Lenders divide the property’s net operating income (revenue minus operating expenses) by the annual loan payments, principal and interest included. A ratio of 1.0 means the property earns exactly what it owes and nothing more. Most lenders want to see 1.20 to 1.35, meaning income exceeds debt service by 20% to 35%. That cushion is what protects the lender if vacancies rise or expenses spike.
Loan-to-value ratios sit well below residential levels. Federal interagency guidelines cap supervised lenders at 65% for raw land, 75% for land development, 80% for commercial construction and multifamily, and 85% for improved commercial property. In practice, most conventional commercial lenders end up between 65% and 80% of appraised value, depending on property type and borrower profile. Hotels, self-storage, and other operationally intensive properties usually land at the low end because their income depends on active management rather than long leases.
Beyond the property, the underwriter runs a global cash flow analysis: every business the guarantor owns, rental income from other properties, personal income, and all outstanding debts across every entity. The question is whether the borrower can still cover the loan if the subject property has a rough stretch. Strong personal credit (generally 700 or above) helps price the deal, but it won’t rescue an application whose property numbers fall short.
Loan Terms, Amortization, and the Balloon
Commercial loans separate two timelines that residential borrowers rarely think about. The amortization schedule (usually 20 to 30 years) determines how the monthly payment is calculated. The loan term (often five to ten years) is when the remaining balance actually comes due. Whatever principal you haven’t paid off by the end of that term becomes a balloon payment. Miss it, and you’re in default.
This is where the product bites borrowers who don’t plan. A property bought with a ten-year term and a 25-year amortization will still carry roughly 75% of the original balance when the balloon hits. Refinancing should start six to twelve months before maturity, because commercial underwriting takes time and market conditions at maturity may look nothing like they did at origination. Higher rates or lower property values at that moment can make refinancing significantly more expensive, or occasionally impossible at the same leverage.
Fixed and Variable Rates
Rates come in two forms. Fixed rates lock in the cost of capital for the loan term, which makes cash flow projections reliable. As of early 2026, conventional bank rates range roughly from the high 4% area to nearly 9%, with CMBS loans typically between about 6% and 8%. The spread reflects differences in property quality, leverage, and borrower strength.
Variable rates float above a benchmark, most often the Secured Overnight Financing Rate (SOFR) or the lender’s prime rate, plus a margin that usually falls between 2% and 4%. The margin stays constant while the benchmark moves with market conditions and Federal Reserve policy. Floating rates start lower than fixed rates but expose you to payment increases if the benchmark climbs.
Borrowers who choose floating debt can manage that exposure with hedging instruments. An interest rate cap sets a ceiling on how high your effective rate can go: you pay an upfront premium, and if the benchmark exceeds the cap, the cap provider covers the difference. Many lenders require one on floating-rate deals. An interest rate swap instead exchanges your floating payments for a fixed rate with no upfront premium, but you lose any benefit if rates fall below the swap rate. Swaps suit borrowers who want certainty; caps suit borrowers who want protection but still want upside if rates decline.
Recourse and Non-Recourse Loans
Whether the loan is recourse or non-recourse may be the most consequential term in the whole document. On a recourse loan, the borrower or guarantor is personally liable for the full debt. If foreclosure produces less than the outstanding balance, the lender can pursue the borrower’s other assets to recover the shortfall. On a non-recourse loan, the lender’s recovery is limited to the property itself, and the lender absorbs any deficiency.
Non-recourse is not a free lunch. Lenders compensate for the added risk with lower leverage, higher rates, and stricter underwriting. CMBS loans are almost always non-recourse. Bank loans, particularly smaller ones, tend to be full recourse with a personal guarantee from the principals.
Even non-recourse loans include “bad boy” carve-outs that flip the loan into a recourse one for specific borrower actions. Filing a voluntary bankruptcy, transferring the property without lender consent, putting unauthorized secondary financing on the property, or committing fraud will trigger full personal liability. Committing environmental waste, letting insurance lapse, or misappropriating insurance proceeds can create limited personal liability for the losses those actions cause. These carve-outs are negotiated at origination and worth reading closely, because the consequences are severe.
Prepayment Penalties
Paying off a commercial mortgage early sounds like a win, but lenders price their returns on receiving interest for the full term, and they protect that yield with penalties. Three structures dominate.
Yield maintenance requires you to pay the remaining principal plus a penalty calculated as the present value of the interest payments the lender would have received through maturity, discounted using a Treasury yield near the loan’s maturity date. When rates have fallen since origination, this is the most expensive option.
Defeasance is not really a prepayment at all. You substitute the real estate collateral with a portfolio of government bonds that replicate the remaining payment stream. The loan continues to exist under a successor entity, and you walk away with unencumbered real estate. Costs include buying the bond portfolio plus fees for attorneys, accountants, and a rated securities intermediary.
Step-down penalties apply a declining percentage to the outstanding balance based on how far into the term you prepay. A common five-year schedule runs 5% in year one, 4% in year two, 3% in year three, and downward from there. Step-downs are the simplest and most borrower-friendly of the three.
CMBS loans almost always require yield maintenance or defeasance. Bank loans more often use step-downs or a lockout period during which prepayment is not allowed at all. Negotiate these terms at origination, because a costly prepayment provision can wipe out a large share of your profit if you sell or refinance mid-term.
Where the Loan Comes From
Who originates the loan shapes the rates, the flexibility during the term, the prepayment structure, and what happens if you need to restructure.
Banks and credit unions are the most common source for small to mid-size commercial loans. They offer recourse loans with flexible terms, step-down prepayment penalties, and relationship-based underwriting. Because they hold the loan on their own books, they can work with you if problems arise mid-term.
CMBS conduit lenders originate loans, package them into bonds, and sell them to investors. Their loans are non-recourse with leverage up to about 75%, but they come with rigid terms, yield maintenance or defeasance, and outsourced loan servicing. If you need flexibility during the term, CMBS is the wrong product.
Life insurance companies offer the lowest rates in the market but underwrite the most selectively. They favor high-quality properties in major markets, cap leverage around 50% to 65%, and scrutinize borrowers exhaustively. In exchange, they offer terms up to 25 years, sometimes fully amortizing with no balloon, and handle servicing in-house.
Bridge and private lenders fill the gap when a property doesn’t qualify for conventional financing because of vacancy, needed renovation, or a tight closing timeline. Rates are significantly higher, terms are short (typically 12 to 36 months), and fees are steep. Bridge debt is a temporary tool used to stabilize a property before refinancing into permanent financing.
SBA 504 and 7(a) Loans
Small businesses that plan to occupy the property they’re buying have access to two government-backed programs with meaningfully better terms than conventional commercial loans. SBA 504 loans are designed for owner-occupied commercial real estate. The structure splits financing three ways: a conventional lender provides about 50% of project cost, a Certified Development Company backed by the SBA provides up to 40%, and the borrower puts down as little as 10%. The maximum 504 loan amount through the CDC portion is $5.5 million. Buying an existing building requires the borrower to occupy at least 51% of the space; new construction requires 60%.
SBA 7(a) loans are more flexible and can fund real estate, equipment, or working capital. The maximum is $5 million. Both programs offer longer terms (up to 25 years for real estate) and smaller down payments than conventional lenders require. SBA 504 rates in early 2026 have run in the high 5% range, well below comparable bank rates. The trade-off is a slower process and more paperwork.
Documents You’ll Need
Commercial lenders want the property’s financial performance and the borrower’s overall financial picture. Assemble the following before you start:
- Three years of federal business tax returns for the borrowing entity (Form 1065 for partnerships, 1120-S for S corporations, 1120 for C corporations), and they must reconcile with the internal financial statements you provide.
- A current year-to-date profit and loss statement and a detailed balance sheet for the borrowing entity.
- A personal financial statement from every individual who owns 20% or more of the borrowing entity.
- A rent roll listing every tenant, square footage, monthly base rent, common area charges, and lease expiration dates. This is the document the underwriter spends the most time with.
- On larger deals, estoppel certificates from commercial tenants confirming lease terms, that they’re current on rent, and that the landlord isn’t in default.
Lease expiration dates get particular scrutiny. A property where 40% of leases expire in the first two years of the loan term looks riskier than one with staggered five-year leases, even at identical current occupancy.
Closing Timeline and Costs
From application to funding, a conventional commercial mortgage typically takes 45 to 65 business days. Once the lender accepts the application, underwriters order third-party reports. A certified commercial appraiser analyzes comparable sales, income projections, and replacement costs to determine fair market value; the report runs $2,000 to $5,000 and takes three to four weeks. Lenders also require a Phase I Environmental Site Assessment to identify potential contamination from current or past uses of the site and surrounding land, at $2,000 to $4,000 for standard property. If the Phase I flags concerns like underground storage tanks or evidence of spills, a Phase II with actual soil or groundwater testing follows, adding significant cost and time.
After underwriting clears the deal, the lender issues a commitment letter with the final terms. At closing, the borrower signs a promissory note (the promise to repay) and a mortgage or deed of trust (the instrument giving the lender a lien on the property). The lender also files a UCC-1 financing statement to secure an interest in personal property and fixtures on the premises, such as trade fixtures and installed equipment that the mortgage lien alone may not cover.
Beyond the down payment, budget for:
- Origination fee, typically 0.5% to 1% of the loan amount and sometimes negotiable on larger deals.
- Appraisal, $2,000 to $5,000.
- Phase I Environmental Assessment, $2,000 to $4,000.
- Title insurance, varying by state and property value; on a $1 million property, premiums often fall between $2,000 and $8,000.
- Mortgage recording taxes where they apply, ranging from about 0.1% to nearly 2% of the loan amount.
- Legal fees for both borrower’s and lender’s counsel, commonly $5,000 to $15,000 combined on a straightforward deal.
On a $2 million loan, closing costs excluding the down payment can easily reach $30,000 to $60,000. These are sometimes rolled into the loan, but doing so raises leverage and monthly payments.
How the Interest Is Taxed
Mortgage interest paid on commercial real estate used in a trade or business is generally deductible as a business expense. Section 163(j) of the Internal Revenue Code limits the deduction for business interest expense to the sum of the business’s interest income, 30% of adjusted taxable income, and any floor plan financing interest. For tax years beginning after 2024, adjusted taxable income is calculated by adding back depreciation, amortization, and depletion, which makes the limit less restrictive than it had been immediately before.
Real property businesses can make an irrevocable election to opt out of the Section 163(j) limitation entirely and deduct all business interest without the 30% cap. The cost is that you must depreciate real property under the Alternative Depreciation System, extending the recovery period for nonresidential property to 40 years instead of the 39-year standard. That slower depreciation reduces the annual deduction for the building. Whether the election makes sense depends on how much interest expense you carry relative to your depreciation, and it’s worth modeling both scenarios with a tax advisor before committing. Land is never depreciable; nonresidential commercial buildings depreciate over 39 years and residential rental property over 27.5 years under the standard system.
What Happens If You Default
Default on a commercial mortgage triggers a faster and less forgiving process than residential foreclosure. The lender can accelerate the debt, demanding the full outstanding balance rather than just the missed payments. Commercial borrowers generally have no statutory right to cure the default and reinstate the loan after acceleration.
If the borrower can’t pay, the lender forecloses. In many states the lender can also seek appointment of a receiver to manage the property and collect rents during the process, preventing deterioration. After the foreclosure sale, if proceeds don’t cover the debt plus fees and penalties, the lender can pursue a deficiency judgment against the borrower on a recourse loan. On a non-recourse loan the lender’s recovery is limited to the property itself, subject to the bad-boy carve-outs.
The practical takeaway: lenders with a performing loan have reason to work with you on modifications or extensions. Lenders holding a defaulted loan have reason to move quickly toward foreclosure. If financial stress is on the horizon, negotiate with your lender before you miss a payment, not after.