Let’s be honest – a mortgage is an invaluable financial tool for those who are looking to purchase a property whether that’s to live in or for business purposes.
Mortgages allow you to purchase properties without having to find the full cost of the property out of your own pocket.
On that note, commercial mortgages are particularly helpful for those who wish to invest in commercial properties like shops or office spaces.
Similar to standard residential mortgages, commercial mortgages are available in two types – repayment mortgages and interest-only mortgages. The first one is quite common, which is why most people are aware of it.
However, interest-only commercial mortgages are less common overall in the mortgage market, which means that fewer people know how they work.
That’s why we have made this guide to discuss interest-only commercial mortgages. So, if you are eager to get started on your journey of commercial property ownership, then read on!
Table of Contents
What Are Interest-Only Commercial Mortgages?
Many people tend to assume that an interest-only commercial mortgage is a distinct type of mortgage available to commercial property buyers.
But that is not entirely accurate since the basic principle of interest-only commercial mortgage is not any different from other types of commercial mortgages.
You get a certain amount of money from a lender to purchase the commercial property. After that, you need to return the borrowed money back to the lender at some point along the mortgage contract.
With that being said, the method of paying back the borrowed money is different in the case of an interest-only commercial mortgage, and that sets it apart from a traditional repayment mortgage.
In the case of the regular commercial mortgage, the monthly mortgage payments take into account both the initial capital and the interest amount.
So, over the course of the mortgage term you are expected to pay back the whole amount in almost equal instalments so at the end of the mortgage term the full balance will be repaid back to the lender including the interest charged for lending the money to you.
On the other hand, an interest-only commercial mortgage requires you to pay only the interest amount in your monthly mortgage payments.
Once you reach the end of the term, you will need to repay the initial capital as a lump sum amount.
Benefits And Drawbacks Of Interest-Only Commercial Mortgages
Needless to say, an interest-only commercial mortgage comes with its set of pros and cons, as we have discussed below.
Interest-Only Commercial Mortgage Benefits
1. Lower Monthly Payments
This is possibly the biggest advantage of getting an interest-only commercial mortgage. Since you only need to pay the interest due on the borrowed amount, the financial strain of the monthly payments is much more manageable here.
Thus, the money you save can be used for investing in other business areas or even developing the commercial property you purchased.
2. Flexible Repayment Terms
If you opt for an interest-only commercial mortgage, you get an option to repay the initial capital anytime before the end of the term.
This can be highly advantageous for commercial property owners, who can repay the money according to their convenience.
Interest-Only Commercial Mortgage Drawbacks
1. Initial Capital Repayment Difficulties
Even though there is less financial strain and more flexibility with an interest-only mortgage, you still need to repay the initial capital amount you borrowed.
And in many cases, commercial property owners face considerable difficulties in repaying this amount.
For instance, if the commercial property fails to bring in adequate revenues, then the owner won’t be able to repay the debt. As a result, the lender may be forced to repossess the property or the property owner will be forced to sell the property to repay the debt, which can be problematic.
Eligibility Criteria for Interest-Only Commercial Mortgages
Getting an interest-only commercial mortgage can be quite beneficial for a commercial property owner. Lenders require you to have a sufficient payment strategy in place in order to repay the capital amount of the loan at the end of the mortgage term.
That is why the lender will thoroughly check your eligibility before approving the mortgage. For your convenience, we have listed the different eligibility criteria for an interest-only commercial mortgage below.
1. Deposits
Most standard commercial mortgages require you to pay an initial deposit of around 20%. However, in the case of interest-only mortgages, you may need to pay a higher initial deposit of 30% to 50%, depending on the financial conditions and the amount being borrowed.
For instance, if the LTV ratio (ratio of the amount being borrowed to the market value of the property) is pretty high, it can increase the risk of the mortgage. So, to minimise this risk, the lender will ask for a higher deposit.
That said, paying a higher deposit for a commercial interest-only mortgage is not as bad as it may seem. In fact, we would recommend a higher deposit amount if it’s available to you as this may give you access to better deals with attractive interest rates.
Of course, you will need to have sufficient funds at your disposal to pay the deposit amount.
2. Mortgage Affordability
Affordability is another essential metric that is checked by the lender before approving the mortgage. For a commercial mortgage, the EBITDA figure will be taken into account for calculating the affordability.
EBITDA, which stands for earnings before interest, taxes, depreciation and amortisation, is a good way to measure the net income and profitability of your commercial ventures.
Naturally, a higher EBITDA will increase the chances of securing an interest-only commercial mortgage and vice versa.
3. Financial Records
The lender will require you to provide detailed financial records of your commercial endeavours for the last two to three years.
This helps them to assess the stability of your business, which ultimately determines how easily your mortgage will be approved.
4. Credit History
Checking your credit history is another strategy that lenders use to evaluate the financial reliability of the borrower.
If you have a consistent record of repaying your debts on time, your credit score will be higher, thereby increasing the chances of getting the mortgage.
On the other hand, if you have several unpaid debts, your credit score will take a hit, which will reduce your chances of getting the mortgage.
5. Proof Of Repayment Strategy
When applying for an interest-only commercial mortgage, you will need to provide evidence of a good repayment vehicle that can be used to repay the debt entirely.
If you have a robust repayment plan, then it will be easier to assure the lender to approve the mortgage.
In this regard, you can utilise different types of repayment vehicles for this purpose, such as:
- Pension
- Investment bonds
- Stocks and shares ISA (individual savings account)
- Endowment policies or regular savings plans
- Unit trusts
- Other commercial properties
- Sale of mortgaged property
- Sale of other property
Conclusion
We hope that the information here has helped you to clear all the doubts and concerns regarding interest-only commercial mortgages. As you can see, such a mortgage can be highly beneficial for commercial landowners, provided that they meet the eligibility criteria mentioned in this guide.
So, if you are looking to purchase a new commercial property, then you can apply for an interest-only mortgage after consulting a broker. If you gather your financial records and other relevant documents then an experienced advisor will be able to search the market for the best possible solution for your needs..
You may need to do some extensive research to find a suitable lender since this type of loan is more specialised with a reduced amount of lenders willing to offer this type of loan compared to a standard residential mortgage.
Seeking advice from an influential broker can prove to be helpful, as they can guide you through the application process and find the best deal for your needs.
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.
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