Residential Mortgage vs Business Loan

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Okay, so we are looking for properties and because we are not your "normal" B&B owners, it is not an easy process.  Namely, there are six of us (two couples, two kids) and we are looking for a larger property for living and farming.  As such, we have to look at converting a property or building from scratch as well as turnkey.  I know that we could get a residential mortgage fairly easily, but it is my understanding that the majority of residential mortgages if not all will not allow any kind of business to be run from the property.  So, we could use that to get started if we had to, but I am worried about then converting it to a business loan, especially since it would be short period of time (less than a year) before we had to switch loan types.

 

Anyone have any experience with using a business loan to pay off your mortgage?  Or have a residential mortgage but still (legally) run the B&B? 

 

Thank you,

Georgina

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OLD thread ... nothing to see here. 

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so sad!!!!!!!!!!!11

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Could be. Most people see sba loans as almost impossible to get. I saw a financial advisor who suggested it to us. He had gotten an sba loan to start his business. It takes longer (he said about 12 weeks once we had all the paperwork submitted) but he suggested it because of the lower down payment. You would face the same challenges with an sba loan as you would with a business loan in that you have to convince a bank that your business is viable.

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We built with a residential loan/mortgage. Then opened the B&B. We checked into changing to a commercial mortgage and it made no sense. Also, when we retire and sell we can sell either as a B&B or as a private home.

Riki

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Question for the masses!

Somebody recently suggested to me that I look into getting a combination of a commercial loan and a mortgage. His suggestion was to put 10% down, try to find a commercial loan that would cover 40 - 50%, and then find a mortgage to cover the remainder. Does this make sense to anyone? 

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That sounds kind of like an sba 504 loan. You put down 10% sba puts down 40% and bank puts down 50%.

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Yes I think that's what he was describing. Does this sound like a viable way to finance a bed and breakfast or small inn? 

Madeleine's picture
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llongendyke wrote:

Yes I think that's what he was describing. Does this sound like a viable way to finance a bed and breakfast or small inn? 

Frankly, this sort of question can't be answered by us except in general terms.

You need to get yourself connected with the SBA or SCORE or an accountant who works with b&b's on a regular basis.

Part of your learning curve is to understand that you have to hire people and make up front investments to make this work.

You can, of course, do the 'seat of your pants' operation of your biz but you really should read that other thread about the biz owner who list everything trying to save money up front.

We really should have listened to the one broker who told us we couldn't afford the places we were looking at. We couldn't. We still can't.

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Madeleine's picture
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Maybe the idea was to get some sort of backing on the loan like from the SBA out other small business group?

Breakfast Diva's picture
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I don't see how that can work. Your house and business are one in the same. The bank loans you money and in return they can foreclose on you if you fail to pay. If you have a mortgage, the bank owns the property, but if there is also a commercial loan, what can they foreclose on?? Doesn't make sense to me.

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Breakfast Diva wrote:

I don't see how that can work. Your house and business are one in the same. The bank loans you money and in return they can foreclose on you if you fail to pay. If you have a mortgage, the bank owns the property, but if there is also a commercial loan, what can they foreclose on?? Doesn't make sense to me.

Well, I don't know.  In a regular commercial building, the business owner often doesn't own the building but can still get a business loan based on some combination of credit-worthiness, business plan and/or inventory.  Maybe you could do the same for a B&B.  Get a residential loan for the property and a business loan for the furnishings, goodwill, market share or whatever that you will use to run the business.

I mean, if a retail store goes out of business with a business loan or investors, what do they get? Not the building, usually.

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Yeah, I don't think this makes any sense either.  Just thought I'd ask in case I was wrong!

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I have not heard of lenders that would loan money in that type of venture.  What works for some type of business ventures might not work for a B&B because right now lenders consider loans for B&B's to be high risk

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From what I understand a business loan does not lock you into a rate. We have a residential loan as we built first and then started the business. It gives us a locked in interest rate. We are an LLC .

Riki

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egoodell wrote:

From what I understand a business loan does not lock you into a rate. We have a residential loan as we built first and then started the business. It gives us a locked in interest rate. We are an LLC .

Riki

Our rate was locked in for 5 years, now it floats. It is scary, to be sure to not be able to plan your mortgage expense every year.

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Madeleine wrote:

egoodell wrote:

From what I understand a business loan does not lock you into a rate. We have a residential loan as we built first and then started the business. It gives us a locked in interest rate. We are an LLC .

Riki

Our rate was locked in for 5 years, now it floats. It is scary, to be sure to not be able to plan your mortgage expense every year.

If I remember correctly, this is why we did not change from a residential mortgage to a commercial one. They could give us a lower rate but only for a couple of years and could not tell us what it would be after that. not worth dropping a couple of percentage points.

Riki

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Your CPA will be able to give you information about how you should structure your business (we are a sub S corp).

Things many have changed over the last few years so again, check with a professional. I would suggest a mortgage broker. It is my understanding that if the property is not a business when you buy it, you can buy it with a conventional home loan. You will be qualified on the income you are making at the time of the purchase. Starting a business after purchase should be ok with most loans.

Our mortgage is a regular mortgage, but we have commercial insurance. Our insurance company sends their notice of coverage to our mortgage holder without any business information on it. We've had 4 different commercial companies over the years and all have done that (and it's normal for them).

If this helps at all, in the last 4 years, I've purchased a private home and also re-financed that same place and the only condition in the mortgage papers that would come close to your issue is that we could not rent the house, it had to be owner occupied. If you are living at the property, you're probably ok.

Of course county/city conditional use permits are a whole other story!

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Understanding what the lender's interest is may be helpful in choosing a lender and in talking to them about how best to accomplish what you want to do.

Whether it is a residential mortgage or a commercial loan, the bank is going to want to know whether you have a sufficient and steady source of income with which to re-pay the loan. With the commercial loan, they will consider your business plan and the income you can generate from the property you are buying with the loan; for the residential mortgage they will expect you to have some other source of income and will not consider the income you can generate from the property you are buying with the loan.

Obviously a residential mortgage is intended for the purchase of property in which you will live, your residence, and not for non-residential, commercial property.

I think the mortgage lender would only care about your actual use of the property, e.g. converting your residential property into a business (B&B/Farmstay), only to the extent that such conversion reduced the value of the property and made it harder to sell as a residence. Besides having enough income to pay back the loan, the bank also wants to make sure that the property has enough value in it to cover the loan amount should you default.

Related to this latter point, the other thing the bank might care about is whether you have adequate insurance. With a residential loan, they want insurance that will cover them if the house burns down, or if someone sues you for injuries suffered on your property. Turning your residence into a business increases some of your liability exposure, so the bank's expectations around insurance might be that much higher.

Basically, the bank wants to make sure that they are going to get paid back, with interest, no matter what. (That's their goal, anyway. They are not always successful, particularly if the market collapses....)

 

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I hope I don't end up sounding extremely dim here, but I've never needed to use a financial advisor or CPA or anything like that before.  So, any suggestions on what I should be looking for?  Do they need to be specialized in B&B's or in business or is this something any financial advisor should be able to help with?   I've been told to look for small, local banks because they are generally more receptive to situations like this but I've no real idea where we are going to be at this point, so I can't look local if I don't know what local will be. 

 

Also, I would just like to say that my sister thinks I am super smart about B&B's and it is really just because I have been reading archives here.  So thanks for all the info ya'll didn't know you gave me =)

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sachi3679 wrote:

Also, I would just like to say that my sister thinks I am super smart about B&B's and it is really just because I have been reading archives here.  So thanks for all the info ya'll didn't know you gave me =)

That makes you one wise cookie Sachi! yes

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I have been laboring over this answer and I've actually confused myself!  But I've decided to throw in my 2 cents worth anyway.

If you're not sure where your property will be and what the loan options are you might want to investigate a seminar run by a B&B broker if none of the other options I talk about below look good to you.  There are going to be variations in zoning for start ups that will vary from city to city, and finding a lawyer to get a business entity set up can occur only after you have found the "perfect" place you want to buy, because any corporation has to be incorporated in the same state.

I live in a state that doesn't have a large number of B&B's, and there were none in my town when I started 6 years ago. So I didn't have access to a local B&B adviser.  However, I did have a good, smart general practice attorney who helped me set up my B&B as an LLC (a type of corporation that does provide some protection for my personal assets).  In your situation with two couples going into business together it is probably even more important to have some sort of legal entity.  

There are a lot of farms in my state, and it is now very common for family farms to incorporate.  Many times there will be several siblings, or a father and his children who all own and operate the farm.  So, you might find the agricultural part is the type of expertise your local professionals can help you with, and can give you examples of legal entities that work out when more than one couple owns the land.  Again there may be some differences depending on what state you end up in.

Even if you decide you don't need a CPA for ongoing tax preparation, there are a whole lot more rules, regulations, and actually in many cases a lot of deductions that are above board that you need to familiarize yourself with.  A CPA and/or an attorney can advise you about the options you have about what kind of business entity would work best, be the simplest for you to file all your own taxes, how to set up your accounting software.

It's possible that neither of the above will be as adept at helping you figure out the nuances of what kind of loan will work out the best, but can help you decide what kind of loans are available for partnerships or corporations, etc.

Financial advisers are a mixed bag of individuals.  Many of them are more into helping you invest the money you have.  There are advisers who specialize in getting B&B's financed and up and running.  There are some who hold seminars for aspiring innkeepers where the education is given with a broad brush.  Attending such a seminar might get you thinking along the lines of what kind of financing you're likely to be able to find, then you can talk to a local bank to see if they will work with you.  These same folks can be hired to help you on an individual basis if you don't find any attorney or CPA to help you out, or if you can't seem to speak the same language the banks are speaking.  On the PAII forum not long ago there was a discussion about hiring a broker (paying him a big chunk of money) to specifically go out and find a loan to buy an existing B&B.  That indicated to me that money is still tight for borrowing money to buy a B&B.

A B&B started up in my town last winter, parents, a married son and their children.  They have already had a serious enough disagreement that they may end up closing because the parents don't like being innkeepers, and the son and daughter-in-law want to buy the business from their parents, but the parents don't want to sell it to them, they would rather sell the house as a residence.  Admittedly, it is likely that none of them "did their homework" before opening, but I have seen other couples who have done the research and after opening have decided not to continue.  Before the need arises, it might be wise to have a document that says what will happen if one or more of the adults in this undertaking "wants out."

There is no question you could ask that makes you seem "dim".  It's the questions you don't ask...

I lurk much more than respond, so my answer might not be what will be the best for you.  That's why it's nice to get lots of answers from people who have had a variety of experiences.  Although I am very comfortable with my advisers whose B&B experience is now up to one (me), if you have easy access to a specialist, I wouldn't discourage you from talking to one.

 

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Thank you so much for your reply.  Even if you confused yourself, you helped me =) 

Figuring out exit plans for each of us is a priority because we do see how this could be an incredible experience for all of us...and also how it could be the worst thing ever. 

We actually did take the seminar you suggested.  I honestly did not find it very helpful.  We started our search using that broker, but have largely moved away from him because it seemed like he was not going to have anything to do with us until we had already picked our property and were ready to sign, in which case I am not sure what the point would be.

I guess I feel like we are very much in a "chicken or the egg" scenario.  There are so many moving pieces that we need to get lined up before we are able to actually do anything. 

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This is very wise information. Thank you Innkeep for writing what I was thinking! The only other thing I would add is that I really think you need to find the property first. You should be able to run some numbers on your own with mortgage calculators (I use bankrate.com) to get you into the ballpark of what you can afford. THEN start looking at properties.

The caution Innkeep gave about partnering with others, even (or especially) with family is fraught with danger. Our initial plan was to buy a larger property with a partner, but chose not to do that and instead, bought a smaller property we could afford on our own. I can look back now and see how it would have been a disasterous decision if we had gone with our partner. Think long and hard over any partnership.

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In my Aspiring Classes, I said unless it is a sole proprietorship (and that is not wise today IMNVHO) one should have an attorney draw up the papers as to who does what (financially) and who gets what should there be a divorce, difference of opinion, closing of the business, death - ESPECIALLY if it is family. It is a case of pay me now or pay me later and the bill later is MUCH more expensive - both financially and emotionally.

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I am in a partnership - for various reasons and to do with inheritance tax which here in the uk is 40% which has to be paid up front (ie you can't sell the house and use it to pay the tax, they work it out and then you have to pay it right then!)

 

However even though it is family everything was done with a solicitor so its all clear and there is no "oh I though the plan was this and so on"

and as the chaps always say " the person you divorce is not the same person you marry"

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Ha, I think that should be "especially because it is family" =)

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sachi3679 wrote:

I hope I don't end up sounding extremely dim here, but I've never needed to use a financial advisor or CPA or anything like that before.  So, any suggestions on what I should be looking for?  Do they need to be specialized in B&B's or in business or is this something any financial advisor should be able to help with?   I've been told to look for small, local banks because they are generally more receptive to situations like this but I've no real idea where we are going to be at this point, so I can't look local if I don't know what local will be. 

 

Also, I would just like to say that my sister thinks I am super smart about B&B's and it is really just because I have been reading archives here.  So thanks for all the info ya'll didn't know you gave me =)

If you have never owned a business before or never owned a business like a B&B/restaurant you can put a layer of protection between yourself and the business and the suing public in case you ever have someone fall, say they got food poisoning, etc. It limits the suing to the business instead of your personal assets.

Your accountant should definitely know about B&B's and how they operate. You want someone who knows all the deductions, etc, but who doesn't try to tell you you can deduct things you can't. And someone who can help you understand the different types of business setups (sole proprietor, S-Corp, LLC, etc)

It's more to get the business set up properly for tax purposes and shielding your personal assets in case of a lawsuit. It's not really for getting a loan. BUT, if you go into a bank for a commercial loan and you have all your tax ducks in a row it makes it look like you really know what's going on. You want to be able to talk the talk and answer the questions the bank will ask.

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No, I've never owned a business before.  I think we will probably do an LLC and am looking into whether we should purchase as an LLC or as individuals.  I was thinking I needed to get a lawyer involved as well especially with the number of people involved, but it sounds like a good CPA or financial advisor should be able to help with everything.  Thanks for your response.

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I agree with Ice, check with your accountant or financial adviser, not only will they be able to help you with this question but also assist you in setting up the structure of the ownership properly for business and tax purposes.  There also may be special needs since it will be financed by more than one family. 

I personally do not think you have to have a commercial loan on a piece of property in order to have a B&B in it.  If the property you desire is currently considered residential and you do not need additional funds to work with, by all means try to go with a residential loan if you can.  You do not need to change the loan structure once you open unless the loan has clauses in it as such. 

Usually commercial loans are required due to the property being purchased was already considered commercial OR you need additional funds to work to create your business. 

Best of luck to you...

 

Ice
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Talk to your CPA.  They will tell you the best way to set it up. My B&B doesn't own the house/land, my husband and I owe it..  I owe the B&B business.  And neither of us lives there!  Only they will be able to tell you the best way to go.

Good luck!

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