How Do Commercial Mortgages Work?

As businesses expand, they often face space constraints due to increased staff, growing sales, the need for more equipment, and more.

Such circumstances lead to a requirement for new premises. And to fund such requirements, commercial mortgages come to the rescue. 

Also termed as business mortgages, these financial tools provide a means for business proprietors to secure the necessary funds for purchasing property or land for their operations. 

Certain property investors will also use commercial mortgages to purchase commercial property that they can let to separate businesses. 

Hence, today, we’ll learn how do commercial mortgages work, shedding light on the key components that drive these financial transactions. So, read on!

What Is A Commercial Mortgage?

Commercial mortgages primarily cater to business owners seeking property or land for commercial purposes.

This is a common path for many successful businesses aiming to establish a new workspace or expand beyond their existing commercial property. 

As such, it is an optimal choice for business owners looking to avoid rising rents and give themselves a level of control over the building. . 

The main distinction between a commercial mortgage and a residential mortgage lies in the considerably larger value of the land or property involved and the purpose behind the way the building is going to be used. 

Plus, commercial mortgages are not typically standardised products, unlike residential mortgages, owing to the vast diversity in land and premises. 

So, if you wish to purchase a commercial property for owner occupation or rental income/capital appreciation, a commercial mortgage is a crucial financial instrument. 

What To Consider Before Applying For Commercial Mortgage?

Before applying for commercial mortgages, it’s crucial to assess your ability to meet monthly repayments like any loan, taking into account your current financial circumstances and any existing loan obligations. 

Failing to manage these commitments can harm your credit score and even lead to property repossession if you default on payments.

Even if you have a less-than-ideal credit rating, mortgage approval is possible, but it may come with a higher interest rate and level of deposit. 

To mitigate this, we recommend reviewing your credit rating before applying.

For owner occupation, new businesses lacking a credit and trading history lenders might perceive them as higher risk. In such cases, they may request personal guarantees and scrutinise your personal credit rating along with your business finances.

This underlines the importance of financial preparedness when seeking a commercial mortgage.

How To Get A Commercial Mortgage?

In contrast to residential mortgages, the availability and suitability of commercial mortgages will vary for each case. 

When seeking a commercial mortgage, you have the option to apply directly to a lender or enlist the services of a specialised commercial mortgage broker.

When evaluating a commercial mortgage application, the lender will conduct checks similar to those for residential mortgages, including assessing affordability and financial standing. 

This typically involves an assessment to gauge the company’s management of existing debts and financial obligations if it is owner occupation or the applicants for those looking to attain a commercial mortgage for purely investment purposes .

The lender is also likely to scrutinise the future business’ profitability occupying the property, to try to gauge the reliance of ongoing rental payments to cover the commercial mortgage. 

Additionally, proof of identity, address documentation, and any lease or tenancy agreements are obligatory. You may also be required to present a business forecast, demonstrating a viable financial plan.

As such, the mortgage application process varies among lenders but generally entails the following steps:

• Go online and fill out a commercial mortgage application form 
• Provide details regarding the business occupying the property. 
• Obtain a property valuation for the premises you intend to purchase
• Wait for the completion of all legal checks and necessary paperwork by the lender
• After approval, receive a formal mortgage offer from your applied for lender. 

How Do Commercial Mortgages Work?

1. Terms

Term lengths can differ significantly. Certain repayment schedules span three years, while others extend up to 25 years, with an average duration typically hovering around 15 years.

The specific terms for the commercial mortgage may be influenced by the amount of the initial deposit, the size of the property, etc. Notably, many lenders provide commercial mortgages with variable interest rates.

It’s essential to remain vigilant for intricate clauses or stipulations, especially in cases where the borrower faces elevated risks. If you face any uncertainties or find the language of the contract confusing, consult a mortgage broker for assistance. 

2. Deposit

Deposit amounts may fluctuate, but typically, commercial mortgage deposits equate to approximately 30% of the property’s total value.

The nature of the business can also influence the deposit requirement. In instances where your business is perceived as higher risk, such as restaurants or bars, certain lenders may request a larger deposit.

3. Fees

There are several fees that may be associated with a commercial mortgage in the UK.

A. Legal Costs

• Borrowers are responsible for both their and the lender’s legal fees
• Costs vary based on property complexity, encompassing insurance, site surveys, and legal document preparation

B. Broker Fees

• Incurred when using a specialist commercial mortgage broker
• These will be higher than the broker charges for residential mortgages usually. 

C. Arrangement Fees

• Typically added to the loan post-approval, but some lenders may demand upfront payment
• Range from 0.5% to 2.5% of the borrowed amount which depends upon the lender. 

D. Valuation Fees

• Appointed valuer assesses the property’s worth before mortgage approval (for mortgage purposes)
• Usually starts at £500, but higher for larger or complex valuations

FAQs

1. Can you switch from a residential mortgage to a commercial mortgage without a penalty?

Your existing residential mortgage provider will be able to determine this. If early repayment charges apply, you may need to settle your residential mortgage first,  incurring the penalty, before a commercial mortgage can overtake it and be registered on the property.

Also, it will be a very rare instance when the property can be used both for residential and commercial purposes. 

2. Can you get a commercial mortgage on a leasehold property?

Yes, you can get a commercial mortgage on a leasehold property, mostly if there is at least 70 years left on the lease but again this will vary depending on the lender.

3. Are there any restrictions on the kind of business you can run?

Commercial mortgages are usually available to most legal businesses, but those perceived as risky investments might encounter challenges in securing one.

Your home may be repossessed if you do not keep up repayments on your mortgage.

All content is written by qualified mortgage advisors to provide current, reliable and accurate mortgage information. The information on this website is not specific for each individual reader and therefore does not constitute financial advice.