Commercial Mortgages: Advantages and Disadvantages
Commercial mortgages can be beneficial for a business looking to purchase its premises. Normally, a commercial loan provider will provide finance to cover most of the Loan to Value (LTV) of the property, and the business will need to provide a minority deposit.
Like all types of business loans, commercial mortgages come with all kinds of advantages and disadvantages, from issues with mortgage repayments to the risks associated with buying your premises outright.
To give you a fuller picture of these mortgages’ advantages and disadvantages, we’ve compared and contrasted the business loan type with others, including renting, normal business loans, and buy to let mortgages.
The Different Options For Securing Business Premises
Before we get into comparing and contrasting the different business loan options, it would be best to identify each of them, explain what they entail, and create a point of reference for the rest of the article. The main financial options for securing premises are as follows:
This is a loan taken out by a company to cover the majority of the price of the new business premises. The premises purchased is to be used on owner-occupied terms, meaning that the owner uses the space solely as a place to work and trade from.
A business mortgage could be used to make purchasing new retail, office, or warehouse space for your business more affordable.
It works just the same as residential mortgages, in that a small deposit is paid first up-front, and the rest of the mortgage is paid back in monthly sums throughout several years. The mortgage will be paid off by the end of the term.
Lenders normally provide around 70 to 80% of the ‘loan to value’ (LTV) of the property. This means that the debtor is expected to pay around 25% of the property price upfront. It is possible to get lenders who offer higher LTV mortgages, and with the right additional security provided, it is possible to get them to pay 100% LTV.
Alternatively, interest-only commercial mortgages are also available, where the debtor only pays interest throughout the term length and keeps the repayment of the loan separate. Once the term is over, the debtor must pay the creditor the original loan back in full. A commercial mortgage term typically lasts up to 30 years.
Many businesses that do not have the funds to invest in a property of their own, and don’t want to take out a commercial mortgage, may opt to simply rent a business property. To rent a commercial building, a lease will have to be signed between yourself and the landlord of the property.
This lease acts as a legally binding contract and permits your company to use the premises to pursue commercial interests. In this contract, a time frame will likely be set as well as the monthly cost of rent, as well as your responsibilities and rights when operating within the rented space.
Rent is normally paid in advance, but it’s possible to pay monthly. Once the rental terms have been agreed, a deposit is normally due before you can start using the property. Like residential renting, the deposit is normally equal to the price of a month’s rent.
A business loan is either a short-term or long-term solution to business cash flow issues. They are used both by startups to help get their enterprise off the ground, as well as established businesses that are going through an expansion period. Business loans can be used to cover anything, from buying new machinery to investing in new business premises.
The loan amount can stretch anywhere between £1,000 to several million and is normally expected to be paid back through monthly repayments over several years.
Besides bank loans, there are several different business loan types available, including bridging loans, peer to peer lending, and revolving credit facilities. Bridging loans are typically taken out to bridge the financial gap between buying one business property and selling the last.
Peer-to-peer lending is the action of receiving a loan from another business in return for interest rates.
Revolving credit facilities is a flexible loan option, where the debtor is free to request to borrow money whenever they need it. An interest rate is added to the money borrowed, and the borrower will need to return the loan by a time set by the creditor.
Buy to let
A buy to let mortgage is for those looking to invest in property. A buy to let mortgage allows you to purchase property with the sole intent of renting the space out to other businesses to use. Like a commercial mortgage, a buy to let mortgage provider will pay around 75% of the LTV, meaning the lender will have to provide roughly 25% of the value as a deposit.
Buy to let mortgages are normally offered as long as the investment property can self-finance, meaning that the property will have to draw in 125% of the monthly mortgage repayment in rent. A mortgage provider will judge the property to determine how much it is worth in rent, before offering a buy to let mortgage.
Owner-Occupier Commercial Mortgage Vs Renting
An owner-occupier mortgage permits the business to work and trade from the premises bought. Renting, on the other hand, only allows the business to work on the property, which is owned by somebody else, for a limited period. When comparing commercial mortgages with rental properties, the biggest advantages can be highlighted.
Advantages of a commercial mortgage over renting
You pay the same for the mortgage as you would in rent
The amount you pay in interest rates is likely to be about the same as you would in rent, particularly if you take out an interest-only commercial mortgage.
With this in mind, it would be more justifiable to take out a commercial mortgage than it would to rent premises, as you’re adding to your assets by investing in property. You may as well pay to both use the property and own it, rather than simply use it.
A commercial mortgage puts you in control
You can rearrange the space freely without having to seek the permission of a landlord, as you would have to in a rented property. This could be beneficial if your business grows over time, as it means you can, if possible, expand the building.
Mortgage payments stay the same
In a fixed-rate commercial mortgage, the amount of interest the debtor pays monthly remains the same. This is hugely beneficial for borrowers, as they can budget and forecast spending a whole lot easier. This is unlike renting commercial premises, as the tenant may be subject to unexpected hikes in rent.
Could potentially sublet the property
Those who take out an owner-occupier mortgage may have the option to lease out excess space they may have in the premises. This can generate a steady flow of additional income for the owner, and can also be used to help pay off the mortgage. This would first need to be approved by the mortgage provider.
It is possible to offset the interest paid on the mortgage against your net profits, which would make it tax-deductible.
Disadvantages of a commercial mortgage compared to renting
There is freedom of movement when renting
If you opt to rent a property, you have much more freedom of movement. You can easily leave one business property and move to another with minimum hassle. Whereas when you take out a commercial mortgage, you’re stuck in the same location until the mortgage term ends.
Although you should consider this drawback beforehand, you may find that a commercial mortgage limits you from expanding your enterprise further down the mortgage term if it turns out you require additional space.
Commercial mortgages require a bigger deposit
The upfront cost of renting business property is also far less than it is with a commercial mortgage. Plus, the deposit required for rented business property is normally returned at the end of the rental agreement.
Mortgages with variable rates could alter monthly repayments
Not all mortgages are fixed rates: some come with variable rates, meaning that the amount of interest you are expected to pay could change from month to month, depending on the Bank of England’s base rate.
The value of the property could go down
After years of paying off the mortgage, you could end your term only to find out that the property has seriously depreciated in value.
Commercial Mortgage Vs A Business Loan
In many ways, commercial mortgages and business loans attained from high street banks feature the same drawbacks. For one, both can feature lengthy application processes, where you’ll have to provide your financial forecast, your trading history, and an outline of your business plan for the future.
Additionally, you’ll also have to meet the strict requirements for eligibility. However, there are more both have several advantages over the other, including the following:
Advantages of commercial mortgages over business loans
Commercial mortgages are cheaper than secured business loans
If you wish to borrow more than £25,000, getting a commercial mortgage would most likely work out cheaper. Unsecured borrowing is generally not permitted for business loans over £25,000. For a loan that exceeds this figure, you’ll likely have to provide some security, just like a commercial mortgage.
Plus, the interest rates for high business loans tend to exceed that of a commercial loan, meaning you’d spend more money in the long run.
A commercial mortgage is cheaper than an unsecured loan
In addition to secured loans, commercial mortgages also have lower interest rates than unsecured business loans. Banks obviously consider unsecured loans to be of a higher risk than secured ones, so will therefore attach higher interest rates to them.
Business loans are far more limited than commercial mortgages
If you are seeking financial assistance to buy a business, a business loan can only cover so much of the loan to value. The likes of a bridging loan are designed only to help you resolve cash flow issues when buying new premises; it does not provide the capital you need to buy the building.
Therefore, you’ll need to save up most of the capital yourself to buy the premises. You cannot rely on a loan to purchase the building like you can with a commercial mortgage.
Long term financial stability
Business loans are generally seen as short term financial solutions. Commercial mortgages, on the other hand, provide long term financial stability, as you can slowly pay it off over 25 years. This means you do not have to take out large sums from your savings to pay it off quickly.
Disadvantages of commercial mortgages compared to business loans
Commercial mortgages have minimum spending caps
It could be a lot more viable to opt for a business loan if you require less than £50,000, as many commercial mortgage lenders often have minimum borrowing caps. Due to the amount of admin and legal costs associated, it is not worth lenders’ time to provide a mortgage of less than £50,000, and it is widely considered to be uneconomical to request such a low figure.
Providing security is not always necessary for business loans
Business loans are generally unsecured, meaning that they do not require the borrower to provide collateral should they default on a payment. This makes taking out a business loan the better option for those who either do not have assets to provide as security or who don’t want to take the risk of losing their property.
You can pay back a business loan quickly
Although a disadvantage for some, having to pay off a loan quickly can benefit others who don’t want to have commercial mortgage repayments limiting their profitability in the long term. If you need quick financial support and can pay it off in under three years, a business loan would be the best option for you.
A bridging loan can be approved within hours
If you require funds quickly, a business loan is definitely the better option for you. Bridging loans can be approved within hours, and funding can be provided within a couple of days.
Commercial Mortgage Vs Buy-To-Let
You take on just about the same level of risk when investing in a commercial mortgage as you do with a buy-to-let one. In both cases, the property you invest in could depreciate over time, making it difficult for you to reach the monthly financial requirements of the mortgage agreement. You are also required to have a good credit score.
However, there are several major differences between the two mortgage types, which includes:
Advantages of a commercial mortgage over buy-to-let
You don’t have to regularly find tenants
For owner-occupied commercial mortgages, you don’t need to fill the space with tenants, as the main tenant is your own business. This is not the case with buy-to-let, as your primary aim is to fill the commercial space with tenants.
Tenants tend to agree to use commercial space on a short-term basis. This means that you may regularly have to find replacement occupants and, in worse case scenarios, have long periods where the property is not being used. This could make paying off the buy-to-let mortgage difficult as you may experience periods of a rental void.
You don’t need tenants lined up before applying
Generally, buy-to-let applicants already need tenants either in place or lined up to fill the tenancy void upon approval of the mortgage. This is to ensure the lender that profit can be made from the property through rent as soon as the mortgage has been approved.
The lender will also need to assess the profitability of the tenant.
You don’t need property letting experience
When applying for a buy-to-let mortgage, the lender often requires the applicant to have previous letting experience in order to ensure that they can be trusted to let out the premises accordingly.
Buy-to-let has increased stamp-duty
Buy-to-let premises are considered to be a second property, meaning an increased stamp duty will be imposed on the property. Owners of buy-to-let property will have to pay a 3% surcharge to cover the stamp duty – this is 3% per each additional property that they own.
Disadvantages of a commercial mortgage compared to buy-to-let
You cannot use a commercial mortgage solely for letting
If you want to invest in commercial property solely for letting, without using it for your own business purposes, you’ll need a buy-to-let commercial mortgage.
A commercial mortgage may require a bigger up-front cost
Although it’s possible to get high LTV rates for a commercial mortgage, you may be more likely to attain one when applying for a buy-to-let. This is because there are fewer risks involved with a buy-to-let property from the perspective of the bank.
Commercial Mortgage Vs Residential Mortgage
Although a residential mortgage cannot be used for business premises, it’s worth weighing up the differences between commercial and residential mortgages to highlight some of the additional advantages and disadvantages of commercial mortgages.
Both types of mortgages do have some similarities; for example, both can take a while to be arranged. The legal and valuation process associated with each can take a long time to get through, which can add up to several months’ worth of wait time.
In addition to this, both mortgage types are long-term commitments, and both have various additional fees associated, such as legal fees, valuation fees, and arrangement fees. But there are also massive differences between the two, which includes the following:
Advantages of a commercial mortgage over a residential mortgage
Commercial properties are worth more than residential
Although there are more risks involved, commercial premises can offer you more profit in the long run than residential property. If you decide to use a commercial buy-to-let mortgagee to lease out your commercial building, you can charge much higher rent per square foot than you can with residential properties.
Commercial properties can be leased out for longer
Should you decide against occupying your commercial building, you could far easier get a long-term lease term for it than you would a long-term tenancy term with a residential property. Lease agreements for commercial premises tend to last between 1 to 25 years. This is much longer than residential tenancies, which typically only last 12 months.
You don’t need to renovate if you lease commercial property
If you use a commercial buy-to-let mortgage to lease your property to a retail business, they will likely have their own business layout in mind and can install it themselves.
Disadvantages of a commercial mortgage compared to a residential mortgage
Commercial mortgages have higher rates
Residential mortgages tend to have lower interest rates because there is less risk involved for the lender. Commercial properties tend to be more expensive than residential ones, so, therefore, require bigger mortgages. There is also more competition when it comes to residential properties, and lenders like to compete by offering lower rates.
Residential mortgages have a longer loan term
Where a commercial mortgage rarely exceeds 25 years in length, residential ones more frequently last up to 30 years.
You’re more likely to get 100% LTV with a residential mortgage
Given the reduced risk that comes with residential properties, mortgage providers are far more likely to offer 100% loan to value on residential property than they are for a commercial mortgage.
Contact Our Brokerage Team To Discover Which Financing Option Is Best For You
At the Bridging Loan Company, we can provide bespoke financing options for you and your business. We are well connected with over 200 specialised loan providers and, after reviewing your specific case, will be able to connect you with whichever ones we believe could best fulfil your requirements.
Get a quote from us today to find out the best business finance options available to you.
What factors do lenders take into account when determining commercial mortgage rates?
Like all types of business loans, there are a number of factors that lenders will consider before either approving or rejecting your mortgage application. This includes:
- Your credit score
- Profit and loss calculations for the coming year
- Business bank statements from the last six months
- Asset and liability statements
- Additional security you’re willing to provide
- Your business plan
- Mortgage history
- Any other indication of current business performance.
How do I choose which way to finance my business property?
The best way to choose which way to finance your business property is to first determine how much money you need. If you require less than £25,000, consider applying for a personal loan or a bridging loan. If you require more than £25,000, consider a commercial mortgage.
To help you choose, it would be best to also consult several mortgage brokers through Loan Corp to get the best rates.
What level of deposit will I need to secure a commercial mortgage?
To secure a commercial mortgage, you’ll most likely need to provide around 20-30% of the LTV.