Guide to commercial mortgages: what you need to know
Are you looking to expand your business premises? A commercial mortgage will get you on the business property ladder but it’s important to know what you’re signing up to and how to compare different mortgage products
As businesses grow, they often start to run out of space. Whether it is because they have taken on more staff, are handling more sales, require more space for new equipment or simply need a bigger shop floor, there are many reasons for moving to new premises.
This expansion can be done in two ways. A start-up which has been run from home could decide to expand by renting somewhere to house the business. Or, it could buy new business premises, in which case a commercial mortgage will likely be needed.
What is a commercial mortgage?
Commercial mortgages, also known as business mortgages, let business owners borrow money needed to buy property or land for their business. Similar to a residential mortgage, the money is borrowed from a high street bank or specialist lender and is repaid in monthly instalments, along with interest.
While commercial mortgages are most commonly used by business owners who want to own the premises where their business is based, commercial mortgages can also be used by investors who want to buy a property to lease to another business, or a residential property owner who wants to buy multiple properties and rent to tenants.
Why buy rather than rent?
Buying business property rather than renting can make financial sense. As well as giving you more control over the building and its use, you will also avoid any rent increases or management fees, although you will be liable for other building costs, such as wear and tear.
Owners also benefit if the property increases in value when it comes to selling in the future. You could also rent the property out, although you will have to comply with the terms and conditions of your commercial mortgage or switch to a commercial buy to let mortgage.
As with any standard mortgage, you will of course pay interest on your commercial mortgage, but the interest is tax-deductible which means you can offset the cost against any tax liabilities.
What is the difference between a commercial mortgage and a residential mortgage?
The main difference between the two is that one is used to buy a home and the other is used to buy business property.Commercial mortgages also tend to be larger as the size or value of the property or land tends to be larger.
Unlike residential mortgages, business mortgages are usually variable rate, so the rate will vary as the Bank of England base rate fluctuates.
Commercial mortgages usually come with higher interest rates as they are considered more high-risk to lenders. However, commercial mortgages usually have lower interest rates than standard business loans as the loan is secured against the property.
While it is possible to get a residential mortgage with a 5-10% deposit, commercial mortgage lenders usually want a larger one, typically between 20% and 40% of the property’s value.
How to get a commercial mortgage
Unlike residential mortgages, which are easy to find and research online, commercial mortgages tend to work on a case-by-case basis. To apply for a commercial mortgage, you can either apply directly to a lender or use a specialist commercial mortgage broker.
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What are the benefits of using a commercial mortgage broker?
Applying for a mortgage can be complex, but using a specialist commercial mortgage broker could help you navigate the process and make it a little easier. They will ensure you have the correct information for the loan application, advise on what products are currently available and which are more suited to you and your business. They will also be able to give a view on how long lenders are taking to assess applications, which could be useful when it comes to securing the best property for your business.
What to consider before applying for a commercial mortgage
Before applying for a commercial mortgage you should consider:
Whether you can afford to make the monthly repayments. Remember to factor in any existing loan repayments you have when working out what you can repay each month. If you are unable to make your monthly commitments, you risk damaging your credit rating and the lender could ultimately repossess the property if you are in default.
If you have a poor business credit rating then you could still be approved for a mortgage but you might be offered a higher interest rate than if you had a strong credit rating. Check your credit rating and see if you could improve your business credit rating before applying if possible.
If you are a new business without a strong credit or trading history then lenders might view you as more high-risk than an established business. If so, they may demand personal guarantees and check your personal credit rating.
What do I need to apply for a commercial mortgage?
In considering a commercial mortgage application, a lender will carry out many similar checks to those applied in a residential mortgage, such as affordability and the financial health of the applicant. This likely involves a business credit check to see how the company manages its current debts and financial commitments as well as any outstanding issues.
The lender is also likely to look at whether the business is profitable and will therefore need at least three months of business bank account statements. Proof of identity and address, as well as any lease or tenancy agreements, is also required. You also might have to provide a business forecast to show you have a viable financial plan.
The mortgage application process
The mortgage application process will vary from lender to lender but typical steps involve:
- Filling out an online application form for a commercial mortgage.
- Submitting information about your business.
- Getting a property valuation on the premises you wish to buy.
- Waiting for the lender to carry out all the necessary paperwork and legal checks.
- Getting a formal mortgage offer from your bank, once approved.
What fees are involved in applying for a commercial mortgage?
There are several types of fees which apply when you are arranging a commercial business mortgage.
Arrangement fees: These are usually added to the loan after the loan is approved, but some lenders might insist on the arrangement fees being paid up front to protect them in case the loan doesn’t go ahead. Arrangement fees vary but are usually 1-2% of the amount borrowed for loans up to £1 million
Brokers fees: You will have to pay broker fees if you decide to use a specialist commercial mortgage broker to advise on what loans are available for your business. This is usually around 1% of the loan value.
Valuation fees: Before the mortgage is approved, a valuer appointed by the lender will visit the property and give their opinion on what the property is worth. Valuation fees can start at around £500 but will be higher in bigger or more complicated valuations.
Legal costs: With commercial mortgages, borrowers are required to pay both their own legal fees, and the legal fees of the lender. Because of the variety of property available in the commercial market, your legal fees will vary depending on the complexity of the work involved. These can include insurance, site surveys and the preparing of legal documents.
Adding any fees onto a mortgage instead of paying them upfront will be a more expensive option if interest is charged on the amount added.
Do I need a deposit for a commercial mortgage?
You will certainly need a deposit for a commercial mortgage and this is likely to be a much higher percentage of the total mortgage than residential mortgages which can be bought with just a 5% deposit. Commercial mortgage deposits tend to range from 20-40% of the loan. You might need to take out a separate loan to cover the cost of the deposit, in which case the affordability checks will also include the deposit loan repayments to make sure that you are able to meet all your financial commitments.
What other types of commercial mortgage are available?
If you are looking to buy commercial property to let out to another business rather than use yourself, you should explore getting a commercial buy to let mortgage.
What alternative options are there to a business mortgage?
If, for whatever reason, you decide that a commercial mortgage is not the best option for your business, there are a number of other finance options available:
Bridging loans can be a short-term funding gap solution which can help you purchase a new property before the sale on another property completes.
Depending on your property requirements, you might be able to meet your needs with a business loan or personal loan, which could be an easier solution. A short-term loan business loan can help you borrow money without signing up to a long-term commitment.
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Sarah Bridge has been writing about business and finance since 2000. She was formerly Deputy Editor, Personal Finance, The Mail on Sunday and was previously the paper's Leisure Correspondent. Read more