A commercial mortgage is a loan secured on a property that is not your residence, which you want to buy for business purposes.
For those looking to finance the purchase of buildings and land for business purposes, a commercial mortgage is probably the best choice, with it being a flexible and affordable option.
They tend to have higher interest rates than residential mortgages, and more variables, but they offer more incentives for borrowers and greater flexibility.
However, until the loan has been fully repaid, the lender has a legal claim over the property, and may foreclose on the property if you fail to meet the repayments and the mortgage goes into arrears.
It is therefore highly important to analyse your finances carefully, and consider the effects that a mortgage will have on your cash flow and assets. While there are plenty of benefits to buying a commercial property, it might be more appropriate to lease, depending on your circumstances.
Types of commercial mortgage
Loans are usually split into two distinctive categories: owner occupier and commercial investment.
- Owner occupier is when the borrower is looking to purchase a business property and/or land for business operations
- Commercial investment is when the borrower purchases a property and/or land as an asset to rent out
Meanwhile, repayments are also split into two main categories: capital repayment mortgage and an interest-only mortgage.
- Capital repayment is when part of the capital is repaid each month, plus the interest
- Interest-only is when only the interest is paid each month. The capital is repaid through a separate arrangement using insurance, asset sales or investment options, but you must prove you will be able to do this
How does a commercial mortgage work?
While there are variations in how commercial mortgages are structured, you will have to decide which interest rate you want to pay: fixed rate or variable rate.
For a fixed rate commercial mortgage, you will pay a set interest rate for a fixed period of time, and then the normal variable rate once the period has ended. This option is generally popular when people are expecting interest rates to rise, or they need to stabilise their monthly payments.
The variable rate is an interest rate that mirrors and changes to the Bank of England's base rate. Initially this rate is lower than a fixed rate, in most cases, but you should always double check. An advantage of a variable rate mortgage is that if the market rate decreases, you save money. However, this relationship also means that if the market rate increases, the rate you pay will increase.
Getting a commercial mortgage
Once a suitable property with the appropriate permissions for the business use is found, there are many competitive commercial mortgages available today, and repayments could well be similar to rental outgoings, or maybe even cheaper.
With a wide range of financial advisers, banks and other financial institutions offering commercial mortgages, there is plenty of choice available. Shop around the offerings from high street banks, building societies and specialist lenders to find the most suitable mortgage for you and your needs.
One of the most important things to consider before getting a commercial mortgage is whether there are any restrictions on the use of commercial premises. You don't want to waste time finding a property and arranging a mortgage to then find out you cannot do what you intended to do with the property.
With regards to a deposit, commercial mortgage loans usually require you to have 20 and 30 per cent of the purchase price of the property. It is possible to find variations however, and some lenders provide 100 per cent commercial mortgages, primarily to small businesses who struggle to raise the initial deposit.
Each lender will have their own eligibility criteria, but generally they all require a number of things before giving you a loan, such as:
- A profit-and-loss forecast for the next twelve months
- Business bank statements for the previous six months
- Current business performance indications
- Audited accounts for the last two years
- Asset and liability statements for each applicant
- CVs and/or profiles of each partner or director of your business
- A full business plan that reveals how the property will contribute to your cash flow and how you intend to repay the loan
Lenders need to be sure that you can repay the entire loan before giving you any money. In addition to this, the value of the business property needs to be more than the amount borrowed, in case you default on the mortgage.
Essentially you need to prove that your business is on a sound financial footing, so that the lenders are confident their investment will be safe.
Advantages of a commercial mortgage
There are a range of benefits to a commercial mortgage. You retain complete ownership of the property, instead of selling a share to an investor to raise funds. If all goes to plan, your business will gain a major asset that may well increase in value over time.
The lender is only entitled to an interest return on its mortgage, and they can only exercise the right to ownership if you default on payments. Furthermore, the interest on a commercial mortgage is tax deductible.
In the long-run, it can prove to be cheaper than leasing a property, and you will have more freedom to do what you want with it. You can refurbish, improve or expand the property, which may increase your earning potential.
The mortgage repayments are likely to be similar to rental payments, so you wouldn't need to budget for additional property expenditure or any increase in rent.
You can sell the property at any time in the future, while many commercial leases are very long-term and there may not always be an option to end the agreement early if circumstances change.
Disadvantages of a commercial mortgage
There are risks involved with a commercial mortgage, just like every other mortgage. It's a long-term commitment that generally takes 15 years or longer to pay off, so you need to think it through thoroughly, it's often harder to relocate, so take this into consideration.
The repayments need to be paid back on time, and failing to do so could result in added interest. If you keep defaulting on your payments, then you may have your property repossessed and sold, and also end up with a poor credit rating. In addition to this, the lender may be authorised by the court to seize your personal assets to satisfy the mortgage.
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