A commercial mortgage is a long-term loan typically used to buy, refinance, or develop properties that will be used for commercial needs. These properties can include office buildings, retail spaces, warehouses, car homes, industrial units, and flats. Commercial mortgages can be taken on a fixed or variable rate with repayment terms ranging from 5 to 25 years.
This financing option could work for you if your business wants to invest in a property to set up a physical presence, expand, or develop new properties. Commercial mortgages give businesses the chance to acquire premises either to trade from or to let to other businesses.
What are the key features of a commercial mortgage
1. Purpose
This type of financing can be used for a variety of purposes such as acquiring existing business properties, refinancing current commercial property loans, or funding the development of new business properties.
2. Term Length
The loan usually lasts anywhere from 3 to 25 years. This flexibility allows you to pick a repayment schedule that works for your own specific needs and circumstances.
3. Interest Rates
The interest rates for commercial mortgages can either be fixed or variable. They’re usually higher than residential mortgage rates because there's more risk involved.
4. Loan-to-Value (LTV)
When it comes to commercial mortgages, the loan-to-value ratio is generally lower than that for residential mortgages at around 60-75%.
5. Repayment Structures
You can usually choose between interest-only payments or repayments for both interest and capital.
6. Tax Deductibility
Interest payments on commercial mortgages could be tax-deductible as a business expense. However, this depends on various factors such as the specific terms of the mortgage and your business structure. To be safe, we recommended consulting with a tax professional or accountant to get expert advice on this matter.
Common Uses of Commercial Mortgages
1. Property Purchase
Businesses can use commercial mortgages to buy premises for their operations, such as offices, retail stores, or industrial units.
2. Expansion
Looking to grow? Companies can use commercial mortgages to purchase additional properties and expand their operations.
3. Refinancing
Refinance an existing commercial mortgage to secure better terms or release equity tied up in the property.
4. Development Projects
Fund new developments or major renovations to existing commercial properties with a commercial mortgage.
5. Investment
Investors can use commercial mortgages to purchase rental properties, such as office buildings or shopping centres, to generate rental income.
Lender Requirements
1. Security
When using the property as collateral for a purchase or refinance, it's important to understand that a professional valuation will be needed to accurately determine its market value. The valuation report is then used by the lender to ensure that the property provides sufficient security for the loan.
2. Business plan
When applying for a loan, you must have a comprehensive business plan in place. This plan should provide a detailed overview of how the property will be used, including proposed income generation strategies and a solid repayment plan for the loan.
3. Credit History
It's important for both the business and company directors to have a strong credit history. When considering loan applications, lenders will look at your businesses financial statements, credit reports, and payment histories.
4. Income Evidence
Proof of the businesses income and profitability is essential for securing a commercial mortgage.
5. Deposit
Borrowers usually need to provide a deposit, typically between 25% and 40% of the property’s value.
6. Debt Service Coverage Ratio (DSCR)
Your lender will assess the DSCR to measure the business’s ability to cover its debt obligations. A DSCR of at least 1.25 is often required, which means that the business generates 25% more income than necessary to cover loan payments.
7. Personal Guarantees
Lenders often require personal guarantees from business owners or directors, particularly for smaller or less established businesses. This means that your personal finances could be at risk if the business defaults on the loan. Lenders may ask for personal guarantees as a way to mitigate the risk associated with lending to businesses that may have limited credit history or financial stability.
Types of Commercial Mortgages
1. Owner-Occupied Mortgages
These mortgages are designed for businesses that intend to use the property for their own operations. This type of mortgage is suitable for those businesses looking to purchase office space, retail locations, or other properties to house their own operations.
2. Commercial Investment Mortgages
This type of mortgage is tailored for investors who are purchasing property with the intention of renting it out to other businesses. It is a popular choice for investors looking to generate rental income and build wealth through commercial property investments.
Advantages of Commercial Mortgages:
1. Tailored Financing
Commercial mortgages offer flexibility in terms of repayment schedules, interest rates, and loan structures to accommodate your company's financial situation and goals. This helps your company secure financing that works with their cash flow and long-term plans, providing stability and predictability in managing debt.
2. Expansion Opportunities
With a commercial mortgage, your business can access substantial funds to help expansion, including acquiring new properties, developing existing real estate, or investing in infrastructure. This financial leverage can propel business growth and enhance market presence, ultimately leading to increased revenue and profitability.
3. Tax Benefits
Interest payments on commercial mortgages could be tax-deductible, providing your company with a valuable financial advantage. By reducing taxable income, you can lower your overall tax liability, effectively optimising cash flow and improving your bottom line. This tax benefit could provide a strategic incentive for businesses to use commercial mortgages for their financing needs.
Disadvantages of Commercial Mortgages
1. Stricter Requirements
Commercial mortgages typically require higher down payments, have more extensive documentation requirements, and may necessitate additional guarantees compared to residential mortgages. Lenders often scrutinise the financial health of the business and its ability to generate sufficient income to cover the mortgage payments.
2. Higher Interest Rates
Commercial mortgages generally come with higher interest rates compared to residential mortgages. This is due to the increased risk associated with commercial lending, as well as the fact that commercial properties often have longer lease terms and higher tenant turnover, which can lead to periods of vacancy and reduced income for the property owner.
3. Increased Risk
If your business fails to meet repayment obligations, it could lead to foreclosure, resulting in the loss of the property used as collateral. Additionally, the value of commercial properties can be more volatile than residential properties, making them more susceptible to market fluctuations and economic downturns.
Final Thoughts
Commercial mortgages are a crucial tool for businesses looking to purchase, develop, or refinance properties. They offer flexible terms and can be tailored to meet the unique needs of each business. However, they come with stricter requirements and higher risks compared to residential mortgages. It’s essential to carefully assess your business's financial situation and prospects before proceeding.
If you think a commercial mortgage might be the right solution for you, we recommend you get specialist advice to help you understand the process and find the best option for your needs.
At L&C Mortgages, we specialise in a wide range of mortgage products, but we do not advise on commercial mortgages. To ensure you receive the best guidance and support for your project, we have partnered with Propp, an expert in specialist property finance. Propp is an award-winning specialist mortgage broker with extensive knowledge and experience to help you secure the right funding tailored to your specific needs.
Important Note on Broker Fees
Unlike L&C Mortgages, Propp does charge a fee for its service. For expert advice on commercial loans, we recommend you contact Propp, who will clearly explain their fees and service before you commit to using them.
Specialist mortgage advice is provided by Propp, who are authorised and regulated by the Financial Conduct Authority (914408). Propp is not a part of L&C, nor is L&C a part of Propp.
L&C receives a % of the commission that our partner Propp earns. All applications are subject to lending and eligibility criteria.
Propp is a credit broker, not a lender, that works with the whole of the market.
The FCA does not regulate commercial mortgages.
