What is a commercial mortgage

Myles

Author: Myles Robinson - Advisor

Posted: Apr 28, 2022

What Is A Commercial Mortgage?

Like many types of financing, commercial mortgages (or business mortgages) can be difficult to understand.

So what is a commercial mortgage, and how can you complete a commercial mortgage application?

Read on to find out everything you need to know about this indispensable type of commercial financing which can help your company buy new business premises.

How Does a Commercial Mortgage Work?

For all commercial mortgages, a lender secures money from either equity investors or the wholesale money markets. The lender then lends the money to businesses, with interest, to generate a profit.

Types of Commercial Mortgages

There are three types of commercial mortgages available. These are:

Owner-occupier mortgages

With an owner-occupier mortgage, a business wants to buy a building that they are already occupying.

Commercial investment mortgages

With commercial investment mortgages, a business buys a property to lease it out. Consequently, these business mortgages are often referred to as “buy to let mortgages“.

Part-commercial mortgages

With a part-commercial mortgage, a business buys a property that has some residential space as well as commercial space.

Who Are Commercial Mortgages for?

These mortgages can be used by any business that wants to increase its cash flow through the purchase and use of new land or property. On the other hand, you’ll need a residential mortgage if you plan to live in the property or rent it out to a tenant who will live in it.

What Can You Use a Commercial Mortgage for?

Businesses can use these mortgages to:

  • Buy new land or property
  • Construct new buildings
  • Refurbish buildings
  • Refinance property.

How Much Can You Borrow On a Commercial Mortgage?

You can borrow around 70% of the market value of a commercial property in most cases. However, it depends on your credit score and the lender you choose.

What Types of Properties Can You Purchase With a Commercial Mortgage?

With a commercial mortgage, you can purchase any land, buildings or real estate that could feasibly be used to run a viable business.

Will You Qualify for a Commercial Mortgage?

To qualify for a commercial mortgage, the following conditions must apply to you:

  • You already own your own home
  • Commercial mortgage deposits tend to be around 30%, so you’ll need this amount of cash
  • You want to buy either a freehold property or a leasehold property that still has at least 70 years on the lease
  • You are the owner of an existing business, or you have managed at least two buy-to-let properties during the last 24 months
  • You require a mortgage that has a loan value of over £25,000.

What Are the Costs of a Commercial Mortgage?

The typical costs of a commercial mortgage are as follows:

  • Arrangement fees – For commercial mortgages less than £1 million, most lenders will charge an arrangement fee of 1-2%.
  • Broker fees – Most brokers charge a fee that’s roughly equal to 1% of a commercial mortgage.
  • Valuation fees – A lender will send a valuer to the property you want to buy. The cost of this service is around £500 – though this can rise dramatically for complex cases.
  • Legal costs – Expect to pay between £1,000 and £2,000 in legal fees. However, this cost will also rise sharply for difficult cases.

Factors to Consider Before Applying for a Commercial Mortgage

Before you start the arduous task of applying for a commercial mortgage, you will need to consider the following factors:

  • Affordability – How do you plan to pay the monthly repayments? How will you pay back the mortgage principal? Lenders offering commercial mortgages will want realistic answers to these questions.
  • Quality of earnings – Lenders will use their expertise to gauge the profitability of your business. For instance, if a large proportion of your revenue is based on credit rather than cash – then mortgage lenders will be reluctant to lend money.
  • Personal Credit Score – If either your business is less than two years old or has fewer than three directors – then lenders will use your personal credit score to determine the financial health of your business.
  • Building issues – If the property you want to buy requires a lot of reconstruction work or maintenance – then lenders might deem your proposal as being too risky.

How to Get a Commercial Mortgage?

The key to the entire commercial mortgage application process lies in understanding the process and having all your paperwork in order.

Applying for a commercial mortgage

In general, there are eight stages to applying for a commercial mortgage:

  1. You discuss your financial needs with either a lender or a specialist commercial mortgage broker.
  2. You submit a preliminary application to a lender.
  3. You submit a full application, along with any relevant reports.
  4. You have a meeting with the lender.
  5. The lender sends a valuer to the property you want to buy.
  6. Solicitors deal with all the legal paperwork.
  7. The lender issues a formal offer.
  8. The lender releases the funds to your bank account.

What you will need to get a commercial mortgage

To get a commercial mortgage, you will need the following:

  • Your completed application form
  • Proof of identification
  • Proof of address
  • 3-6 months of personal bank statements
  • 2-3 years of financial accounts for your business (including balance sheets, income sheets, and cash flow statements)
  • Financial projections for your business
  • Details concerning the property you intend to buy (location, type of building, etc.)
  • For commercial investment mortgages – a copy of your current tenancy agreement and an itinerary of your investment properties.

Commercial Mortgage Deposit Requirements

For most commercial mortgages, the required deposit is 20-40% of the price of a property you intend to buy.

How Do Interest Rates On Commercial Mortgages Work?

The interest rate of a commercial mortgage has two components: the base rate and margin.

Base rate

Within any economy, the “base rate” is the rate that banks lend money to each other on an overnight basis. The number is expressed as an annualised rate.

For a long time within the UK, the base rate was set via LIBOR (London Inter-Bank Offered Rate). However, because of scandal and rate manipulation – LIBOR has been replaced with SONIA (Sterling Overnight Index Average).

SONIA rates are produced every day by the Bank of England. You can find further information on the Bank of England’s SONIA interest rate benchmark here.

Margin

You can think of the base rate as the rate lenders pay to borrow money from either investors or the wholesale money market. If lenders then want to lend this money to you, they will need to charge you the base rate and an additional rate to generate a profit. This additional rate is called the margin.

The margin rate depends on many things, including:

  • Economic conditions
  • The lender’s operating expenses and business model
  • The creditworthiness of your business and yourself
  • The property you intend to buy.

What Is the Difference Between a Commercial Mortgage and Residential Mortgage?

There are three significant differences between commercial mortgages and residential mortgages:

  1. Lenders view residential mortgages as being less risky than commercial mortgages. Consequently, you can secure a residential mortgage with only a 5% deposit – but for most commercial mortgages, you will need a deposit of at least 20%.
  2. Many residential mortgages have fixed rates. However, most long-term commercial mortgages have variable rates (i.e. their interest rate follows the base rate).
  3. Residential mortgages are regulated by the Financial Conduct Authority (FCA). The FCA does not regulate commercial mortgages.

The Pros and Cons of a Commercial Mortgage

Pros:

  • Capital gains potential
  • Lower interest rates, compared to unsecured lending
  • Potential extra income via letting or sub-letting (subject to appropriate approval).

Cons:

  • Requires a large deposit
  • Owning property incurs extra costs related to maintenance, administration, etc.
  • Monthly repayments will fluctuate
  • Can result in negative equity during economic recessions.

Can You Get a Commercial Mortgage if You Have a Bad Credit Score?

Yes, you can. However, your choice of potential lenders will be limited. This is because many lenders will see your personal finances as a reflection of your business acumen.

Furthermore, lenders will ask for a sizeable deposit from you (i.e. far above the typical 30%) to reduce their financial risk.

So, improving your credit score is a good idea before applying for commercial property mortgages.

Alternatives Options to a Business Mortgage

If you can’t get a commercial mortgage, then you could explore one of the following options:

  • Personal loans – The interest rate will be higher, and the debt duration will be shorter. But the paperwork will be easier.
  • Bridging loans – This is a short-term loan to help people who are on the verge of completing the sale of a property.
  • Development loans – This is an arrangement whereby a lender will release funds to a borrower at certain stages of a construction project.

How Can a Commercial Mortgage Broker Help You?

A commercial mortgage broker can:

  • Offer useful advice about business mortgages
  • Help you deal with all the paperwork and correspondence that is necessary to get a commercial mortgage.

Also, it is important to note that many lenders will only lend money via a mortgage broker.

Final Thoughts

Please do not be put off by all the technicalities and paperwork of commercial mortgages.

If you are a skilled business owner, then in the long-term, commercial mortgages are an inexpensive way to expand your business without diluting your equity.

FAQs

Can you get a commercial mortgage without a deposit?

No, you can’t. However, you could borrow money (via a personal loan) – and then use this money as a deposit for a commercial mortgage.

How soon can I receive a business mortgage?

The entire process to get a business mortgage usually takes 8-10 weeks, unlike residential mortgages, which are typically received more quickly.

What is the difference between a recourse and a non-recourse mortgage?

Suppose a borrower defaults on a recourse mortgage and a non-recourse mortgage. Assume both mortgages were secured against an office building (i.e. the building was collateral for both mortgages)

With the recourse mortgage – the lender can attempt to recover their financial losses by:

  1. Making claims on collateral, and;
  2. Pursuing additional assets that belong to the borrower.

With a non-recourse mortgage – the lender is only allowed to make claims on collateral that were stipulated in the original loan contract.

How is commercial LTV calculated?

To calculate the LTV ratio (or ‘loan to value ratio’) of a commercial mortgage – just take the value of the mortgage and divide it by the price of the property you intend to buy.

For instance – suppose a business owner wants a mortgage of £350,000 to buy a building worth £500,000. Then the LTV ratio of the mortgage would be equal to £350,00 / £500,000 = 0.70, or 70%.

For commercial mortgage lenders, lower LTV numbers mean less financial risk.

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