Understanding Commercial Mortgages

FundingCommercial mortgages can be difficult to understand for first-timecommercial property buyers. In this guide, Gary Hemming of ABC Finance will break down exactly how commercial mortgages work, when they are used, the likely costs and how to navigate the commercial mortgage application process successfully.

Commercial mortgages can be used to purchase a property for your business to trade from, or to fund the purchase of a commercial investment property. In this guide, we will predominantly focus on mortgages for business owners who are looking to purchase a property to trade from or refinance their existing business premises.

What is a commercial mortgage?

A commercial mortgage is a long-term loan which is primarily secured against commercial property, such as office buildings, factories, warehouses, or even agricultural land and buildings. As with residential mortgages, commercial mortgages can be used to purchase or refinance the property.

Although commercial mortgages are generally associated with purely commercial properties, in reality, almost any property can be considered as security. Common security can includeland, apartment blocks and other predominantly residential properties, such as houses with equestrian facilities and large houses which are used as B&Bs.

Commercial mortgage uses

Commercial mortgages can be used to purchase property or to refinance an existing debt. There are a number of reasons why people choose to remortgage a commercial property, the main ones are:

  • To get a better interest rate
  • To change the monthly payments (up or down)
  • To release equity from the property

The commercial mortgage application process

Commercial mortgage applications tend to be manually assessed, this is an area that differs greatly from residential mortgages. Most lenders will have set criteria that they are guided by, although there is always scope for discretion, where reasonable.

Typical interest rates and charges

The rates charged will depend on a number of factors, with rates usually coming in between 2.5%-7.5% per annum. Lower rates will almost always be offered for lower risk applications, with the lowest rates often offered to well-establishedbusinessfor larger loans.

Most commercial mortgages are written on variable rates – either linked to the Bank of England Base Rate or LIBOR. Fixed rates can be offered by most lenders. If you would prefer to fix your rate, just ask and you will usually be given several options.

On top of the interest charged, there are usually a number of fees to pay when arranging a commercial mortgage.

The first (and often largest) is the lender’sarrangement fee, a fee charged for setting up the loan. The lender arrangement fee usually comes in between 0.75%-2.5% and it can usually be added to the loan or paid on completion.

The next cost to consider is the lender’svaluation fee. The valuation fee is charged for a survey of the property by a chartered surveyor and allows the lender to understand the value and condition of the property and whether it is suitable security for the loan.

The valuation fee is usually charged after the loan has been agreed by the lender, often as the final stage in the process before the mortgage offer is issued.

As with residential mortgages, there are certain legal fees that need to be paid when arranging a commercial mortgage.

Unlike residential mortgages, you are usually expected to pay the lenders legal costs in addition to your own legal costs.

If using a broker, there may be a broker fee to pay to them for them arranging the mortgage. The fee charged can be as much as 2% of the loan amount, although 1% is more common. Although most broker fees are charged on completion, some brokers do charge non-refundable upfront fees.

The pros and cons of using a commercial mortgage to raise finance for your business

Although the first thing that comes to mind when thinking about commercial mortgages is the purchase of a new property, commercial mortgages have other uses. They can be a strong option when looking to raise finance for a business. Here we will break down the main pros and cons.

Pros

  • The rates offered are much lower than other types of finance – refinancing via a commercial mortgage to fund growth or expansion can be beneficial as commercial mortgage rates tend to be lower than other types of business finance products, often by a significant margin.
  • Borrowing can be arranged over a longer term – Commercial mortgages are usually available for up to 20, or even 30 years. This reduces the monthly payments, which can be a great help to those with tight cash flow.
  • It can be easier to pass affordability assessments – Combining low interest rates with being able to borrow over a longer term can make it far easier to pass affordability assessments as the repayments are lower than other forms of finance. This means that you may be eligible for a commercial mortgage, but unable to secure a business loan.
  • Security makes it easier to borrow for those with adverse credit – If your credit file is less than perfect, it may be difficult to secure most types of unsecured business finance. This is not the case for commercial mortgages, with lots of lenders happy to consider adverse credit.

Cons

  • It can take a long time for the application to complete – whereas most unsecured lending can be completed in under 1 week, commercial mortgages usually take 6-8 weeks.
  • There are additional legal and survey costs – These can cost a significant amount, especially for larger loans.
  • Some lenders charge early repayment charges – If you’re looking to repay the loan, this can negate the savings made by securing a lower interest rate.
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