A guide to commercial mortgages
What is a commercial mortgage?
A commercial mortgage is similar in principle to a residential mortgage except it is used to purchase a property or to raise capital for commercial purposes rather than domestic purposes. As with residential mortgages, the lender retains rights to the property until the loan is repaid in full.
What would you use a commercial mortgage for?
The types of property that people might purchase using a commercial mortgage could be anything from hotels, restaurants, shops and takeaways to office buildings, factories, warehouses and farms. Sometimes people might buy the business and property at the same time if the two are intrinsically linked, such as a hotel or restaurant. When properties are purchased to be used as business premises, the mortgage is known as a commercial owner-occupier mortgage.
Alternatively, a commercial mortgage could be used for refinancing. People might want to unlock capital from their existing business property to expand or improve their premises or facilities, or to raise cash for any other business purpose.
There are many other uses for a commercial mortgage, such as buy-to-let mortgages, where people purchase a property (perhaps residential) as an investment and let it out, or commercial development mortgages, where people purchase a property to develop it and sell it on for a profit.
Why purchase premises rather than rent?
Taking on a commercial mortgage is a major leap for your business and must be carefully considered before entering into the commitment. However, it can be an excellent investment and owning the business premises that you occupy can bring many advantages to your business:
In most circumstances the proceeds of the loan are not considered to be taxable income and the interest payments are tax deductible.
You’ll have a clear repayment plan, with terms and rates tailored to suit your needs. (See below for more details on this.) This means that you can manage your cash flow more easily.
Mortgage repayments can be cheaper than rent.
Any property purchase is an investment. Your asset could appreciate a great deal in value, thereby increasing your capital.
You have the potential to make money by subletting. For example, you might have space in your property that you don’t currently need, and could make money on it by letting it out to another business until you need it to expand your own business.
Why use a commercial mortgage to raise capital?
If you already own business property and need cash for your business for any reason, unlocking the capital in your property by refinancing or remortgaging is an effective solution. Think of it as a loan that could be used for any business purpose – not just expanding or improving your premises. There are many benefits in doing this:
Commercial mortgages can be easier to obtain than business loans, especially for small businesses, as the property provides security to the lender.
Unlike many business loans, which tend to have a short repayment term, commercial mortgages cover a long period – anything from 15 to 25 years, depending on the lender and the financial circumstances of your business.
In most circumstances the proceeds of the loan are not considered to be taxable income and the interest payments are tax deductible.
There are two ways in which you might use a commercial mortgage to raise capital for your business:
1. Refinance your current commercial mortgage to include the loan amount that you wish to borrow.
2. Release the equity that has accumulated in your current property, i.e. the current value of the property minus any outstanding mortgages or debts tied to it.
What are the costs and repayment options for commercial mortgages?
Repayment plans tend to be similar to residential mortgages. The main options are either fixed rate or variable rate repayment mortgages or interest only/endowment mortgages.
Unlike residential mortgages, however, the interest rates for commercial mortgages tend to be higher as business lending is perceived as more of a risk. The rates will vary depending on the circumstances of your business, but generally speaking, the higher the risk, the higher the interest rate. For the same reason repayment terms also tend to be shorter than residential mortgages – typically 15-20 years.
It’s likely that you’ll also need to raise a deposit, as most lenders won’t provide 100% loan-to-value mortgages – i.e. they won’t provide a mortgage for the full purchase amount and will expect a down payment from you as a form of security (typically 20-30% of the purchase price, although some lenders accept as little as 5%, but with a higher interest rate for repayment).
Other expenses to consider are the setup costs involved in arranging a commercial mortgage, such as legal charges, surveys and broker fees.
In terms of responsibility for repaying the mortgage, this depends on the type of business. If you’re a sole trader the responsibility will lie with you and you may also be personally liable should you default on the repayments – meaning that you could lose personal assets as well as the commercial property that is mortgaged. If you’re in a partnership, the responsibility and liability apply to all partners. If it’s a limited company, the responsibility and liability belong to the business, although personal security may be required to approve the mortgage depending on the profitability of the business.
How do you obtain a commercial mortgage?
When applying for a commercial mortgage, you’ll need to do your homework and build a strong business case to demonstrate your company’s ability to repay the mortgage. Be prepared to undergo a thorough examination of your finances, including:
business history of your company: financial statements, profit and loss accounts, balance sheets, past and current cash flow, all certified by an accountant.
future projections for your company: long-term business plan, intended use of the property, earnings potential, projected cash flow.
personal finances: the financial histories of yourself and all other key stakeholders in the business, such as credit worthiness and past earnings.
All of these factors will determine the lender’s perceived degree of risk in lending you the money, which will in turn determine the term and interest rate of the loan that they are willing to give you.
The obvious first step to many people applying for a commercial mortgage is to approach their bank or business lender, with whom they already have an established relationship. However, for this very reason it’s unlikely that you’ll receive a competitive deal.
The best way to get a commercial mortgage is to use the services of a specialist independent mortgage broker, who can help you get a good package to suit your needs whatever your circumstances. Even if your credit isn’t great, it doesn’t mean that you won’t qualify for a commercial mortgage. Having a broker to represent you will really strengthen your case. They have access to a wide range of lenders and understand their criteria for lending, as well as your specific needs. They can therefore undertake a targeted search, increasing your chances of finding a suitable loan. In fact, the broker may even be able to obtain several different options from various interested lenders, which provides the scope to negotiate a fantastic deal for you.
Money isn’t all that you’ll save. Imagine if you tried to apply to several lenders yourself – think of the time taken to complete all the applications, and the time wasted in applying to unsuitable lenders. The independent advice and specialist knowledge that a broker provides are invaluable.