When it comes to securing a mortgage in Canada, the process for obtaining a residential mortgage and a commercial mortgage differs significantly. While both types of loans require the borrower to prove their ability to repay the loan, the underwriting requirements for each are distinct due to the different types of properties being financed, the associated risks, and the purpose of the loan. Below, we’ll explore the key differences in underwriting requirements between securing a commercial mortgage and a residential mortgage in Canada.
Property Type and Purpose
The primary difference between residential and commercial mortgages lies in the type of property involved. Residential mortgages are used to finance homes, including single-family residences, condos, or multi-unit properties (up to four units). In contrast, commercial mortgages are used to finance properties intended for business use or income generation, such as office buildings, retail spaces, industrial properties, or multi-family apartment buildings with five or more units.
The purpose of the property significantly influences the underwriting process. Residential mortgages are focused on individual borrowers, whereas commercial mortgages are typically extended to businesses or investors who intend to generate income from the property.
Residential Mortgages:
The underwriting process for residential mortgages is primarily focused on the borrower’s personal financial situation. Key factors considered by lenders include:
- Credit Score: A strong credit score is a critical factor in securing a residential mortgage. Lenders usually require a minimum score of around 600-650, but higher scores (700+) are preferred for better loan terms. A borrower’s credit history provides insight into their ability to manage debt and make payments on time.
- Income Verification: Lenders need to ensure that the borrower has a reliable and stable income to cover the mortgage payments. This includes reviewing pay stubs, tax returns, and employment verification documents.
- Debt Service Ratios (GDS/TDS): These are ratios that determine what percentage of your gross household income go to servicing the property you are purchasing, gross debt service ratio (GDS) and the total debt outstanding that you have on your file, the total debt service coverage ratio (TDS). Your GDS includes the subject property expenses, namely mortgage payment, property taxes, and $100 for heating. Your TDS includes your GDS expenses, along with any other debt you have to pay for on a monthly basis, like credit cards, car payments, student loans, or other mortgages.
- Down Payment: The minimum down payment for residential mortgages in Canada is generally 5% for homes under $500,000, and 10% for every dollar over that price. Larger down payments can help secure better mortgage terms.
Commercial Mortgages:
In contrast, securing a commercial mortgage involves a deeper assessment of both the borrower’s financial health and the income potential of the property. The underwriting process for commercial mortgages is much more complex and typically includes:
- Business Financials: Lenders will scrutinize the financial health of the business or investor applying for the mortgage. This includes reviewing detailed financial statements, business tax returns, profit and loss statements, and balance sheets. The goal is to assess the borrower’s capacity to handle large loan payments and sustain business operations.
- Property Income Potential: Lenders place a significant emphasis on the property’s ability to generate income. For commercial properties, this means reviewing the property’s rental income, current leases, and future income projections. For owner-occupied businesses, we need to calculate how much business income the property can help to generate.
- Debt Service Coverage Ratio (DSCR): A key metric for commercial mortgages, the DSCR measures whether the property generates enough income to cover the mortgage payments. Typically, a DSCR of 1.2 or higher is required, meaning the property must generate 20% more income than required to cover debt obligations.
- Loan-to-Value Ratio (LTV): Commercial mortgage lenders generally have more conservative LTV ratios than residential lenders. While residential mortgages may offer up to 95% LTV (with mortgage insurance), commercial mortgages often require LTVs between 65-80%, meaning the borrower must contribute a larger down payment.
Risk Assessment
Residential mortgage lenders focus on individual borrowers and their financial capabilities. Since residential properties are typically low-risk (assuming stable housing markets), the underwriting process is more standardized. In contrast, commercial mortgages are inherently riskier due to the greater potential for business fluctuations, tenant turnover, and economic conditions that could affect rental income. As a result, commercial mortgage lenders require more detailed information, including business plans, property income projections, and a higher level of financial scrutiny.
Regulations and Flexibility
While both types of mortgages are regulated by Canadian financial institutions, residential mortgages are more heavily regulated by government entities like the Office of the Superintendent of Financial Institutions (OSFI) and subject to specific rules, such as mortgage insurance requirements and stress tests. These rules are designed to protect individual borrowers and ensure financial stability in the housing market.
On the other hand, commercial mortgages are less regulated by the government, offering more flexibility for lenders and borrowers. As a result, lenders can negotiate terms such as interest rates, repayment schedules, and loan amounts more freely, depending on the specific financial situation of the business or investor.
In Summary:
Securing a residential or commercial mortgage in Canada involves navigating different underwriting processes. Residential mortgages place heavy emphasis on the borrower’s personal financial profile, including income, credit score, and debt levels. Commercial mortgages, however, require a more in-depth analysis of both the borrower’s business and the income-producing potential of the property. The underwriting process for commercial mortgages is more complex and conservative due to the higher risks associated with business properties. Understanding these differences can help borrowers prepare for the unique requirements of each type of mortgage, ensuring a smoother and more successful financing experience.
When seeking a commercial loan, speaking with a commercial mortgage broker with experience In the field is invaluable compared to a broker or specialist who only works in the residential space. If you would like to book a meeting with the commercial broker at Mortgage Powered Financial Group, click here.
