What is a commercial mortgage?
Is your business buying its own premises or are you a property developer looking to finance a new project? Are you a commercial landlord or a private landlord with a substantial portfolio? If so then a commercial mortgage might be a good solution to finance your property purchase.
Here we take a look at how commercial mortgages work and explain the different types of commercial mortgage. We also examine the pros and cons of a commercial mortgage and answer frequently asked questions.
Table of Contents
- What is a commercial mortgage?
- What are the pros & cons of a commercial mortgage?
- How do I apply for a commercial mortgage?
- Frequently asked questions?
What is a commercial mortgage?
A commercial mortgage is a short or long-term business loan secured on a property. It is an umbrella term that includes mortgages to buy a business premises, property development loans and investment mortgages for landlords. However some lenders use the term “commercial mortgage” to solely refer to mortgages for businesses buying their own premises.
Commercial mortgages work like residential mortgages. Lenders will value the property and assess your business’s eligibility before offering a mortgage. Lenders offer a variety of terms ranging between 3 months to 30 years depending on the type of commercial mortgage.
Just like a residential mortgage, commercial mortgages usually include a discounted or fixed interest rate period. After the discount period ends, your business may decide to remortgage with another lender.
How does a commercial mortgage work?
Commercial mortgages work in different ways according to the type of mortgage and the terms of your agreement with the lender. They include mortgages to finance your business buying it’s own premises and mortgages for developers and business landlords.
Once you have been approved for a commercial mortgage, your agreement will include the following information:
- Mortgage term - this varies depending on your type of mortgage and the use of the building.
- Interest rate - flexible and fixed interest rates are available, although some lenders only offer variable interest rates on development mortgages.
- Discount period - this varies between lenders and the type of commercial mortgage.
- Fees - lenders usually charge arrangement and valuation fees.
- Early repayment charges - your agreement will set out any repayment charges if you decide to repay the loan before the end of the term.
What can I use a commercial mortgage for?
Commercial mortgages can be used to finance the purchase of a range of commercial properties including the following:
- Owner-occupied business premises - your business can apply for an owner-occupier mortgage to purchase a warehouse, factory, retail or office space rather than renting.
- Rental property - business landlords use investment mortgages to buy property to rent out to business or residential tenants. A portfolio mortgage is more suitable for private landlords with a large property portfolio.
- Development property - property developers, both businesses and individuals, can use a commercial development mortgage to purchase land or a building for a development project.
Types of commercial mortgage
Commercial owner-occupier mortgage
A commercial owner-occupier mortgage can be a great option if your business is buying its own premises. Lenders often charge higher interest rates than for residential mortgages but lower than for a commercial development mortgage. Some lenders offer terms of up to 30 years, although you can apply for a shorter mortgage term of anything above 3 years if this is more suitable.
Second charge finance
A second charge mortgage may be a good option if your business owns a property with a significant level of equity. You can release equity to fund your business operations or another property purchase.
Real estate finance
Real estate finance is an umbrella term for a commercial mortgages used by property developers or business landlords. It includes loans for residential property developers; commercial property developers; commercial property landlords and private portfolio landlords.
Residential or commercial property development
A development mortgage is designed for commercial or residential property developers. Lenders often agree shorter borrowing terms of up to 3 years on this type of mortgage. You will need to make sure the mortgage term gives you enough time to complete your project and sell your development. Interest rates are more expensive than for residential mortgages and owner-occupier commercial mortgages and some lenders only offer variable interest rates.
When you apply, lenders assess the gross development value of the land or building (the value of the development once it is finished). They usually ask for a business plan, evidence of your track record on similar developments and details of your intended timeline and sales strategy. You will increase your chances of a mortgage approval by getting planning permission on the proposed development.
What is a commercial investment mortgage?
A commercial investment mortgage (sometimes called commercial buy-to-let mortgage) is used by business landlords to fund property purchases. You will usually need a significant deposit of around 20%-40% of the total property value. Lenders offer mortgage terms of up to 5-25 years and fixed and variable rates are normally available.
When you apply, lenders assess the value of the property and the expected rent as well as considering the financial health of your business. Some lenders will only agree to a mortgage if you have a tenancy agreement in place or a sitting tenant (you are buying a property from a previous landlord and the tenant is still in place).
What is a portfolio buy-to-let mortgage?
A portfolio buy-to-let mortgage is designed for private landlords with substantial property portfolio of over 10 properties. If you are a private landlord with a large property portfolio then it may be possible to save time and cut down on arrangement fees by combining all your buy-to-let mortgages into one portfolio mortgage. Some lenders also offer commercial investment mortgages to portfolio landlords.
Lenders assess portfolio buy-to-let mortgages in a similar way to commercial investment mortgages.
What are the pros & cons of a commercial mortgage?
Pros
- Affordability - most businesses and individuals do not have enough cash saved up to buy a property outright. A commercial mortgage allows them to spread the cost over a longer period.
- Cheaper borrowing - commercial mortgages offer cheaper interest rates than other types of business loan because they are secured on a property.
- Long loan period - some types of commercial mortgage are available for a much longer term than a standard business loan.
- Simplifies borrowing for landlords with big portfolios – a portfolio mortgage allows professional landlords to consolidate debt and simplify admin. They can have one loan rather than 20 different buy-to-let mortgages.
Cons
- Ties up some cash - as you will usually need a deposit of at least 20% of the property value.
- Property at risk - if your business doesn’t keep up repayments, the lender might repossess the property.
- Long-term commitment - an owner-occupier commercial mortgage is often a long-term commitment of up to 30 years.
- May affect credit rating - if your application is refused it could affect your personal or business credit rating.
- Slow to arrange - a commercial mortgage is often slower to arrange than other types of business loan.
How do I apply for a commercial mortgage?
Commercial mortgages are available from banks, brokers and specialist lenders. Your business applies for them in a similar way to applying for a personal mortgage.
Lenders assess your business’s mortgage application based on their lending criteria and the property valuation. They perform business or personal credit checks and look at the affordability of repayments. Most lenders will ask for the following information:
- Length of time in business - some lenders will only consider applications from established businesses
- Latest financial statements - to assess the financial health of your company.
- Level of existing debt - to assess if your business can afford repayments.
- Gross Development Value (GDV) - this is for development mortgages only. GDV is a measure of the value of the development once the work is completed.
- Business plan - if you are a property developer the lender will want to see a well-structured business plan as well as evidence of your track record for similar developments.
Here are some commercial mortgage lenders:
Are there any other options?
If you want to buy a commercial property for your business but don’t want a commercial mortgage, here are some other options:
- Bridging loan - a type of short-term funding of up to 12 months to pay for building and development costs.
- Refurbishment bridging loan - a specific type of bridging loan to finance refurbishing an existing property.
- Auction finance - if you buy a property at auction, some auction houses provide specialist auction funding. This is a short-term lending option and may require repayment within 28 days.
- remortgaging - if your business already owns property portfolio you may be able to remortgage those properties to release equity. You can then expand your business’s portfolio without tying up cash or committing to a new mortgage.
Frequently asked questions
Most lenders will only offer commercial mortgages to businesses with a significant deposit of at least 20%.
Lenders won’t usually approve 100% commercial mortgages. However, if your business has addition assets to offer as security, then it may be possible to secure a mortgage with only a small deposit. You will need to provide evidence of a long trading history and strong financial performance.
The amount your business can borrow depends on the lender’s criteria and the value of the property you intend to purchase.
Lenders will often agree to a higher mortgage amount if you apply for a flexible rate of interest. Some lenders restrict borrowing to a maximum of £10 million on a fixed rate mortgage.
Just like a residential mortgage, lenders charge fees for a commercial mortgage. You will need to pay a valuation fee for the property, an arrangement and security fee when the loan is arranged and an early exit fee if you decide to repay the loan early.
Interest rates on commercial mortgages are normally higher than for a residential mortgage. However some lenders offer interest only mortgages so this can save significantly on short-term costs.
Typical interest rates for a development mortgage start at 4.5% per year but may be more if you are a new developer or have a small deposit. If your business is buying its own premises or is a commercial landlord then interest rates start at around 2% per year.
Most lenders don’t offer residential mortgages on commercial properties.