What is a commercial mortgage?

If you’re looking to expand your business, or the cost of renting commercial premises has become too great, you may be considering investing in a property. Chances are, you’ll be looking to explore the range of commercial mortgage options on offer as a potential source of business finance and you’ll quickly discover that there’s a lot to be aware of.

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What is a commercial mortgage?

Commercial mortgages, often referred to as business mortgages, are used by business owners predominantly to acquire commercial properties. Given the high price of commercial rents and management fees, many limited companies are deciding to opt for a commercial investment as a hedge against the spiralling costs of doing business in the UK.

One of the main differences between a commercial mortgage and a mortgage on a residential property is the value of the property and the loans available are more tailored than the off-the-shelf residential consumer mortgages; these tend to vary less in terms of base rates and arrangement fees. That is despite commercial mortgage lending products aligning with the European Mortgage Credit Directive (MCD), which applies to both commercial and residential mortgages.

When would I need a commercial mortgage?

Generally speaking, a business will apply for a commercial mortgage when it is looking to expand its business premises or to secure an additional rental income stream by subleasing a property to other businesses or residential tenants—this is mainly done through buy-to-let mortgages. A commercial mortgage usually lasts from three to 25 years and it is possible to get a 70%+ mortgage (the percentage of loan-to-value ratio.) As a rule of thumb, the recommended loan-to-value ratio should be under 80%. That said, many lenders will offer loans above 80% up to 95% but the interest rate on these loans will be significantly higher.

What is a buy-to-let mortgage?

Buy-to-let mortgages are the main vehicle for business owners to become landlords by purchasing a commercial property and subsequently renting it out to a tenant. You will most likely be eligible for a buy-to-let mortgage if you:

  • Plan to invest in houses or apartments

  • Have a healthy financial situation 

  • Understand the risks involved in investing in property

  • Already own a home, outright or with a residential mortgage

  • Have a good credit history

  • Earn £25k + a year, anything less than that is usually below the threshold for a typical mortgage lender

Will be less than 70-75 years old when a typical 25-year mortgage ends, i.e if you apply for a commercial mortgage at the age of 60 you will be ineligible as by the time you finish your repayments you will be 85.

How do buy-to-let mortgages work?

Most business owners who decide to apply for a commercial mortgage will do so by first setting up a limited company, this reduces the risk of you losing personal assets, for example, your home may be repossessed. If you buy property via a limited company you have limited liability, and thus only risk losing what you put in. Mortgage terms can vary from lender to lender. Some key considerations:

  • Interest rates are higher

  • The minimum deposit is usually 25% of the property value (range is 20-40%)

  • Most BTL mortgages are interest-only. You pay interest each month, but make no repayments on the capital amount. At the end of the term, you will have to repay the original loan in full

  • Advising and lending BTL mortgages for consumers fall under the same laws as residential mortgages and are regulated by the FCA

Eligibility for buy-to-let mortgages in the UK

Residential mortgages are a lot easier to secure than their BTL commercial cousins, especially for applicants who don’t own a residential home. Lenders in the UK have strict eligibility criteria, but the market is varied and with the help of a lending platform you can quickly compare the market. Many lenders, for example, are content to transact with businesses with a poor credit history. In cases where your situation is distinctive, it can be beneficial to scan the entire market via a single platform to quickly find UK lenders that allow applicants with your specific criteria. Most UK lenders use the following criteria to assess a new commercial mortgage application often described by the lender as “subject to status.”

  • Income (minimum £25k per annum)

  • Deposit (25-40% depending on the level of risk)

  • Borrower status (limited companies, partnerships, offshore companies, sole traders, LLPs)

  • Credit history (if you have imperfect credit or a history of bankruptcy or insolvency, it is essential to target specialist lenders)

  • Age of borrower (the borrower must be between the ages of 18 and 75, however, many lenders will reject applications from borrowers who will be 75+ when the repayment term has been completed

  • Applicants must be UK based

How to get a commercial mortgage loan?

To get approved for a commercial mortgage you will need to prove that you can meet the repayment terms. Thus, you could be asked to produce a detailed business plan to demonstrate this. Also, it’s likely that a professional valuation will be required prior to securing the commercial mortgage. 

As detailed below, you can find a commercial mortgage through a high street bank, challenger bank or specialist lender. If you opt for a high street bank, you might have to move your business bank accounts to get the best possible terms. Some specialist lenders offer interest-only commercial mortgages, and may also offer a mortgage with a lower deposit (although in these cases interest rates tend to be higher). 

How much can I borrow?

The amount you can borrow through a buy-to-let mortgage will depend on the amount of rental income you can earn. A typical lender will expect to see rental income that is 25-30% higher than the repayments on your mortgage. You can get an idea of the average chargeable rent for your property by talking to a local letting agent, or by checking online rental listings for similar properties.

Commercial mortgage deposit

As is the case when you buy a family home, a commercial mortgage deposit is the money you pay to the lender based on a percentage of the property’s sale price. The lender provides you with a mortgage, so you purchase the property and repay the bank over time. Generally speaking, the more you pay as a deposit the less you’ll have to repay on the mortgage. 

How much deposit do I need for a commercial mortgage?

The deposit amount for a commercial mortgage is usually between 25% and 40%. This figure will depend on a number of factors, including the level of risk your business poses to the lender. 

Owner-occupied commercial mortgages tend to have a 70% to 80% loan-to-value (LTV) ratio, which refers to the size of your mortgage in relation to the value of the commercial property you want to buy. The LTV for a commercial investment mortgage rarely exceeds 75%, unless the business is going to provide extra security.

What is a bridging loan?

This is a form of short-term borrowing to fill a gap in funding until your cash flow situation improves. An example of when you might need a bridging loan would be if you have just sold a commercial property, but are waiting for the payment to reach your bank, and you have another property that you want to purchase in the meantime. It’s important to note that security may be included—a bridging loan will be secured against your property, so if you don’t meet repayments a lender can include your home as an asset to be repossessed. There are two different types of bridging loans: a closed bridging loan; which includes a fixed repayment date and fixed rate, and an open bridging loan where there is no fixed repayment date (commonly one year payback period.)

Average commercial mortgage rates

Commercial mortgage rates will depend on the level of risk and can rise or fall depending on the evidence you provide when you apply.

When it comes to pricing an application, the lender will consider the loan size, LTV, credit history and your business’ financials, as well as a range of other factors. Typically, the interest rate will tend to be lower if you intend to use the property as your business premises versus if you plan to lease it out. 

When it comes to owner-occupied mortgages, rates can be anywhere from around 2.25% to 18%. Commercial investment mortgages on the other hand tend to have higher interest rates - they usually range between 3.5% and 6%.

Rates can be fixed or variable. It’s possible to get a fixed-rate commercial mortgage for anywhere from two years to the length of the loan. Variable rate commercial mortgages track either the Bank of England Base Rate or LIBOR (London InterBank Offered Rate).

Broadly speaking, commercial mortgages can be used for three purposes:

Owner-occupied

Commercial mortgages for owner-occupiers are usually for two business situations: either a company wants to purchase the premises where it currently operates, or it wants to buy a new premises to move into.

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Residential buy-to-let

Another common scenario for commercial mortgages is the purchase of residential property to be let out. This area is commonly used by professional landlords with a property portfolio, as well as buy-to-let limited companies set up for the same purpose.

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Commercial buy-to-let

Similar to the above, you can use commercial mortgages for commercial buy-to-lets as well. For example, you might want to purchase a warehouse via your company and let it out to another business. Although this type of mortgage is similar to residential buy-to-let, the lender will look at different factors because in general it’s more difficult to rent out commercial properties.

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Lenders

There is a wide range of lenders offering commercial mortgages, each with their own pros and cons.

High-street banks

The obvious benefits of the major banks are that if you’re eligible, their rates are tough to beat. They’ll often lend against the OMV and offer quite high LTV, which means you may get a larger mortgage, and the big banks are also more likely to have shorter and less onerous tie-in periods.

The downsides are that their criteria can be more difficult to satisfy. They require a fairly high DSCR, which means you need a higher income to service the same amount of debt than you would with other lenders, and if you have recent credit issues they’ll often turn down your application outright. Also, the process of applying for a commercial mortgage can take a long time with the major banks, with decisions regularly taking more than 3 months.

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Challenger banks

The challenger banks generally have a greater appetite to do business, and can help some of the businesses that their high-street cousins can’t. First, their DSCR requirements are usually lower, which means their income threshold for commercial mortgages can be easier to satisfy. They will also consider applications with credit issues in the last two years, which the major banks won’t usually do.

Challengers sometimes offer interest-only repayment options up to the maximum LTV, which makes sense for businesses who buy their premises for cashflow reasons rather than capital gains — for example where the interest-only mortgage payment would be less per month than their current rental payments.

The downsides of the challengers come down to cost and flexibility — in general, they’re more expensive than the high-street banks, and will often have higher exit fees for the duration of the mortgage, which may limit your options if your future is uncertain.

Challengers may also agree the commercial mortgage amount based on a 180-day marketing period rather than the OMV, which can potentially lower the amount you can borrow.

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Niche lenders and specialists

Compared to both types of bank, the smaller specialist lenders are a lot more flexible overall. If you want a commercial mortgage but haven’t been in business long, the niche lenders may be your best bet, because they are often prepared to lend to shorter trading histories and have lower affordability criteria (DSCR). In some cases, it’s even possible to use projections instead of trading history if they’ve been signed off by an accountant.

The specialist lenders may also be more flexible in terms of location, considering applications for mortgages in most areas of the UK and in some cases even offshore territories. These situations will be looked at on a case-by-case basis, however.

As you might expect, the downside of these types of lenders is the cost — they’re usually more expensive commercial mortgages than those you’ll get from the banks. The smaller lenders tend to lend against the FSV too, which is usually lower than OMV and therefore can significantly reduce the percentage of the property value you can borrow.

They’ll also have longer terms, and more restrictive exit fees. For example, you may have a tie-in period of 8 years on a 10-year mortgage with exit fees ranging from 2–6% — significantly more restrictive than the banks. Having said that, if your situation means you’re only eligible for the specialist lenders, the comparison with major banks is irrelevant.

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Eligibility & criteria

Each lender will have a slightly different risk assessment process so it's worth shopping around and doing some research on the different eligibility criteria for each.

Trading history is important

When it comes to getting a business mortgage, your trading history matters. Lenders want to know that your business can afford the mortgage and will be able to repay it. If you run a limited company that’s currently trading, you’ll need at least 3 years of filed accounts to be eligible for the high-street banks, and at least 2 years of accounts for the challengers.

If you’re thinking of buying a property to start a business, you’ll need to have a significant lump sum to put in yourself. Typical loan-to-value ratios for a brand new business with no trading history will be a maximum of 50% of the purchase price, so to purchase a property worth £200,000 you’d need a minimum of £100,000.

For professional landlords looking to get commercial mortgages for residential rental property, you’ll need to demonstrate previous experience in this area, usually at least 1 year.

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What you do with the property matters

Not all commercial mortgages are created equal, and how you use the property makes a difference to both the interest rate you’ll pay, and how much you can borrow.

For example, owner-occupied businesses such as offices or shops can normally get a maximum loan-to-value of around 80%. But, if you decide you want to split your office building into smaller units and lease some of these, then that’s a different story. Now you’ve crossed over from an owner-occupied business to a commercial buy-to-let business, and your maximum LTV drops to 75%. What’s more, your interest rate goes up too, so now you’re looking at rates starting from 3.00% over the Bank of England base rate.

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Location, location, location

If your company already owns lots of properties in the same area of the country, getting a new commercial mortgage might be difficult for the banks because you’ve reached what they call the ‘concentration limit’. The idea is that if the market in that area goes down, you’re much more exposed than you would be with a portfolio of properties spread all over the country.

Planning permission is also important, because it has strong implications for the future profitability of the site. However, some of the challenger banks and niche lenders will consider commercial mortgage applications without planning permission.

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There’s always an exception to the rule

In the UK there are over 70 lenders who specialise in business mortgages, from high street banks through to niche lenders. If you can put together the right business case, you can often find a lender who is willing to offer you a business mortgage, even if on paper you might not meet all the criteria.

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Why not look at some of our tips for taking out a commercial mortgage:

Understand how much equity is in your security being offered

Unfortunately, it’s not a simple case of using your property or asset’s market value as a guide to what you can borrow. The more accurate gauge is to use the remaining equity in the property. Lenders assess different valuations – often, the forced sale value – and they take into account any outstanding debt against the security, for example previous debentures or charges. In general, you will need to have remaining equity of at least 75% of the value of the property you are looking to buy.

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Insufficient cash deposits to cover the rest of the purchase

In this case, lenders may ask for additional security to help you purchase the property. It is often the case that a lot of your cashflow is tied up in business operations or existing property, so providing additional security can be a good option for those businesses and sectors that find themselves asset-rich but cash-poor.

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There are lots of lenders in the market and each prefer different assets

This is a key point that many prospective buyers don’t fully understand, and it is a major reason for using a service like Funding Options. To secure large mortgages, different lenders will only accept certain types of assets. For instance, some lenders prefer taking second charges, rather than the first charge, against property. Others prefer to take certain types of property as collateral, like residential properties, pubs or warehouses. They even have different preferences when it comes to using sites and land as security, and the location of the asset can also be a factor.

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The extra fees associated with buying new property

Don’t forget that you will also have to include the valuation fees when using security in any funds lent — this is in addition to the usual legal and arrangement fees. The Funding Options team can help to clarify what you should expect in terms of fees as the process nears completion and, in some cases, we may even have access to cheaper alternatives for you.

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How to choose

The variety of commercial mortgages on the market is excellent for commercial borrowers. Here’s a quick run-down of the important things to bear in mind when looking for a commercial mortgage.

Fixed Rate vs. Variable Rate

You can get fixed rate mortgages for a period of time which ensures your monthly repayments do not increase, there are variable rates which can change, and there are even “blended” rates (a mix of the two). This is an important choice, because it determines not only your monthly payment amount, but also how much equity you’ll build up in the purchased property, and how quickly.

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Stamp duty

Stamp duty land tax is payable on properties that cost £150,000 or more. The amount your business pays is a percentage of the purchase price of the property. Your accountant can best advise with regards to your tax liabilities.

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Interest Rates

Commercial mortgage interest rates can be fixed against the base rate or the LIBOR (the rate at which banks lend to each other). In addition, lenders will require a cash deposit or additional security which will help offset the risk.

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Renting Part of Your Premises

This can be a viable option and the rent can help with your monthly mortgage repayments. Due to its complex nature, it would be recommended to speak to one of our business finance experts to explore this great option – and see if it would suit you.

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Extra Fees

You will have to pay a small percentage for arrangement and legal fees when you purchase commercial property, so it’s worth speaking to the lender and an intermediary like Funding Options who can explain these terms simply and ensure you know the full cost. It is also worth considering refurbishment costs, with the more organised factoring this into initial costs when selecting their property.

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Why use a mortgage broker?

Commercial mortgages are complex and regulated products. You typically require higher deposits than residential loans, and a financial provider will need to assess your application.

Mortgage brokers and lending platforms like Funding Options are here to assist you on your journey to secure a commercial mortgage. Here are six reasons a lending platform can help:

Expertise

We’re experts in the field, with many years of experience in sourcing the right mortgages for our clients’ needs. We’ll help you find the best way to finance your plans, and while it’s beneficial to do some price comparison yourself, you don’t want to be applying for finance at every bank and lender you come across, as it may affect your credit rating if you’re rejected.

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Access to the whole market

As experienced professionals, intermediaries have the knowledge of all the latest products and innovations in property finance. We assess your case not just for the high street banks, but for alternative providers too, so you have access to a wide range of products to see if they could work for you.

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Relationships with lenders

Mortgage intermediaries have good relationships with lenders and the people that actually make the final calls, so your application will be underwritten with the best possible case for success being made. Sometimes, online forms just don’t have the relevant fields in which to show you can run your company successfully — we’ll make sure your case is presented fairly.

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We’re on your side

Intermediaries are there to work for you, to get the right deal for your situation. We’re impartial and objective, and we’re happy to spend time guiding you through all the complex terms and conditions you should expect with a mortgage. That means you’ll be aware of all the repayments you need to make, alongside any extra charges or fees, and you can feel safe in the knowledge that you’ve got the right mortgage for your situation.

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Honest explanations

Perhaps a commercial mortgage isn’t right for you at moment. If so, instead of wasting your time, we’ll explain to you exactly why you wouldn’t be accepted, and explore all your alternative options. Often it’s better to know immediately that you’re on the wrong track, rather than spend weeks in the application process just to be declined at the end of it.

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We’re a one-stop-shop

As a business owner, your time is limited, and we know you’ve got other things on your mind. While you may want to evaluate dozens of financial providers on the market yourself, with an intermediary you can concentrate on running the business and let the experts do their job — saving you time and energy.

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Glossary

Buy-to-let (BTL)

A property which you want to purchase with the aim of letting it out to another party.

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Debt service coverage ratio (DSCR)

A measure of the cashflow you have available to pay your debt obligations — in other words, the ratio of your monthly repayment amount versus your overall cashflow position.

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Forced Sale Value (FSV)

The asking price you could achieve if you were forced to sell the property as soon as possible. Forced sale value is usually lower than Open Market Value because you wouldn’t have time to wait for the best offer to come in.

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Loan-to-value (LTV)

The ratio of the amount you want to borrow versus the total value of the property. For example, to purchase a property worth £1million at an LTV of 75% would mean your mortgage covered £750,000 and you’d have to put in £250,000 yourself.

LTV is an important metric in commercial property finance because it determines how much of a buffer the lender has between the potential sale price and the amount lent, and therefore has implications for the risk of the deal.

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Open Market Value (OMV)

The asking price you could achieve if you could afford to wait for a few months to sell the property. Open market value is usually higher than Forced Sale Value because you have time to wait for the best offer to come in.

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Planning Permission (PP)

Formal legal permission from a local authority for the development or alteration of property, commonly needed for most commercial and residential developments.

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Standard Variable Rate (SVR)

The variable interest rate of a mortgage which is determined by the mortgage lender’s discretion, rather than the Bank of England Base Rate.

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