How Does Commercial Mortgage Insurance Work?
Much attention has been paid to residential mortgages since the onset of the 2008 financial crisis. However, lenders do not only advance mortgages to homeowners. There is another type of mortgage called commercial mortgages. These mortgages are advanced based on commercial, not residential, properties. A commercial property is property used for business purposes such as a shopping mall, apartment building, or industrial property; in other words, it is meant to bring in revenue for the owner.
Mortgages for properties like these are classified into two categories: Owner-occupied commercial mortgages and investment commercial mortgages. If the owner uses fifty-one percent of the property or more for business purposes, the former category is applied; if the owner uses fifty percent of less for business purposes, the latter category is applied.
The most common purpose of a commercial mortgage is to purchase land or commercial real estate for the purpose of establishing a business. If conditions are favorable, a commercial mortgage loan provides much-needed liquidity and start-up capital. Commercial mortgages can also be used to fund the expansion of an existing business.
As with all mortgages, commercial mortgage insurance exists for commercial mortgages as well. Commercial mortgage insurance works a little differently than residential mortgage insurance. This is only natural: homeowners are usually not using their house for business purposes. Mortgage insurance for commercial properties work by guaranteeing that the borrower’s immediately family will not lose the property by failing to make the payments should the borrower die. This also protects the lender from any potential loss of revenue, as well. Technically speaking, mortgage insurance of both the residential and the commercial varieties falls under life insurance.
A major disadvantage of commercial mortgages over residential mortgages is that the interest rates are typically much higher. This is because while the revenue prospects of commercial real estate are obviously much better than those of residential real estate, commercial landlords are much more likely to look at repaying the mortgage as a “business decision” rather than a personal one, and are thus more likely to default on their debt. There is also another reason: commercial mortgages are amortized for much longer than residential mortgages. Due to intense speculation among both types of real estate, there is understandable concern that this speculation could create artificial volatility in the real estate market.
In a recession, this concern is even more pronounced. The good news for lenders is that commercial mortgages are more likely to bear fruit than residential mortgages are. For this reason, lenders are willing to amortize the mortgage for longer periods of time. Commercial mortgage insurance for commercial real estate harmonizes with this tendency because the insurance will cover both the borrower’s family and the lender should the borrower die.
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