As a small-business owner, you should regularly analyze your expenses and know where you're spending your money. Many business owners realize that their rent payments could be better spent by instead purchasing property and building equity in real estate. Few businesses will buy a property outright. Instead, most will take out a loan to finance the purchase.

When taking out a loan, you sign a promissory note (or note) that legally obligates you to pay back the money.

At the same time, you give your lender a mortgage, which is a lien on your building that provides the lender with a security interest in the property. This means that you have put your building up as collateral for repayment of the loan. If you fail to pay the loan, the mortgage allows the lender to foreclose on your property.

In some states, the security interest in your building is called a deed of trust, which is essentially the same thing as a mortgage.

You can get a mortgage loan from mortgage companies, banks, savings and loan associations or building and loan associations.

Mortgages can be either:

  • Guaranteed (to be paid) by an insurance company or a federal agency
  • Conventional loans, which are not insured by governmental agencies

Common Types of Mortgage Loans:

  • Fixed-Rate Note: The interest rate and the amount you pay each month stay the same for the entire life of the loan. You'll always know how much you owe each month, and you may be able to take advantage of a low interest rate.
  • Adjustable-Rate Mortgage (ARM): The interest rate changes at regular intervals, sometimes as often as once a year, and is tied to the interest rate on U.S. Treasury securities. There is usually a lifetime cap of the maximum percentage points your loan can increase over the length of your loan, and restrictions on how much your loan can be adjusted upward in a particular adjustment period. An adjustable rate mortgage should include both kinds of restrictions.
  • Hybrid Rate Note: The interest rate stays fixed for a certain number of years, then changes to a variable rate. Some ARMs are also hybrid-rate mortgages.
  • Balloon Note: The interest rate stays fixed for a certain number of years, then the remainder of the loan amount comes due at a certain time.

Questions to Consider

Before deciding on a specific type of mortgage, ask yourself the following questions, which will help guide you toward an appropriate mortgage:

  • How long are you planning to stay in your building? The longer you plan to own a property, the more you should consider a fixed-rate mortgage.
  • What's the most you can currently afford to pay each month for commercial space? A fixed-rate mortgage comes with the security of knowing that your mortgage payments will never change. But if you can afford to pay more, you should consider an ARM or hybrid mortgage, which will usually offer a lower introductory interest rate, but may end up costing you more money in the future if interest rates increase.
  • Is the economy on the upswing or the downswing? If you think that interest rates will decrease over time, you're better off with an adjustable or hybrid mortgage, which allows you to take advantage of changes in rates. A fixed-rate mortgage is better if you think interest rates will rise in the future.
  • How is your credit rating? The higher your credit score and the fewer problems on your credit report, the more mortgage options will be available to you.
  • How much money will you have to pay up front for the loan (e.g., points and loan fees)? Some mortgages offer lower interest rates in exchange for an upfront payment of points (equal to a certain percentage of the total value of the mortgage).

The Mortgage Process

Once you've narrowed down the type of mortgage you want and the mortgage lenders available to you, you'll apply for and then close on (finalize) a mortgage loan.

It's important to fill out the mortgage application thoroughly and provide copies of your earnest-money agreement, tax returns, business plans or other documents the mortgage lender requests.

If you're getting some of the money for your down payment from a relative, the mortgage lender will probably require a letter from them stating how much they're contributing, and whether the money is a gift or a loan.

If you're "pre-qualifying" by shopping for a mortgage before you've found the building you want to buy, the mortgage lender will give you a lock-in agreement or loan commitment letter to guarantee the terms of your loan for a certain period of time.

If you're thinking about moving in a couple of years, it may not be prudent to take out a shorter term loan with a higher interest rate. And don't pay upfront costs to get a lower rate if these costs are going to be more than what you would save in lower mortgage payments over the few years that you plan on staying in your building.

Watch out for:

  • Bait and switch tactics. Don't be conned into a more expensive loan after you've applied for one with lower interest rates.
  • Dishonest mortgage brokers. Get any guarantees in writing, and check them out with your local Better Business Bureau. All fees should be fully explained upfront.
  • Negative amortization. When your monthly payment doesn't cover the monthly interest that's due, you end up owing more on the principal amount of your loan each month. More frequent with ARMs, it's a trap you don't want to fall into.