Everything You Need To Know About A Commercial Mortgage
Whether you are an established business looking to grow, or you’ve taken the first step into the world as a start-up. A commercial mortgage can add security and continued investment for your business by purchasing a property.
If you have enough capital to buy a suitable property, there should be no problems. But what if your budget is limited? How would you run a business without a property?
Luckily, you can apply for a commercial mortgage and get the necessary funds needed to buy the property. Things aren’t that straightforward, though; there are many considerations that you need to account for before getting a commercial mortgage.
In this guide, we’ll discuss everything you need to know about a commercial mortgage, so you can make an informed decision and avoid drowning yourself or your business in debt.
What Is a Commercial Mortgage?
A commercial mortgage is a mortgage that business owners take to buy property. Instead of purchasing the property in cash, business owners borrow the money needed to buy the property while also securing the mortgage using the to-be-bought property as collateral.
And while commercial mortgages are originally designed for businesses, it’s not uncommon for investors to utilise them by buying properties and leasing them to businesses. Some property owners also opt for this type of mortgage to buy new properties and rent them.
Commercial mortgages have monthly interest rate fees that vary based on your financial situation and the property’s value.
Interest rates aren’t the only costs associated with commercial mortgages. There are some fees that you need to take into consideration when planning out this major financial move, which include:
Arrangement fees are fixed fees that lenders charge on commercial mortgage candidates. These are either added to the mortgage’s value or paid upfront. Many lenders prefer to charge them upfront just in case the mortgage doesn’t get approved. Arrangement fees can be anywhere from 1 to 2% of the mortgage’s value.
You don’t always have to opt for a broker, but if you do benefit from the services of a broker, you’ll have to pay them. Brokers usually charge around 1% of the mortgage’s value.
There’s some legal work involved in the application process of commercial mortgages, which include but isn’t limited to:
- Issuing of legal documents
- Site surveys
You can either pay these fees upfront or add them to the mortgage’s value. Just keep in mind that any additions to the mortgage may cause interest fees to be unreasonably high.
Valuing the property is a mandatory requirement when applying for a commercial mortgage. To get an estimate of the property’s value, the lender will hire a valuer to assess the property, and the costs will be paid by the borrower. Valuation fees shouldn’t exceed £700-£800.
Types of Commercial Mortgages
Commercial investment mortgages and owner-occupier mortgages are two common types of mortgages. A commercial investment mortgage is when an investor seeks to buy a property for renting purposes. Commercial investment mortgages are a bit riskier than owner-occupier mortgages, especially if the investor will rely on rent payments to repay the loan.
On the other hand, with owner-occupier mortgages, the borrower is typically a business owner who wants to buy property for business use.
Benefits of a Commercial Mortgage
Here’s a quick overview of the perks of getting a commercial mortgage:
Repaying your commercial mortgage in fixed monthly payments over the years allows you to factor it easily into your business expenses.
Just because you got your property with a commercial mortgage doesn’t mean that you can’t rent a part of it to gain some additional cash. This income can help you repay the loan more smoothly.
Great Alternative to Rental
If you choose to rent a property instead of getting a commercial mortgage, you’ll end up paying hefty rent fees every month.
On the flip side, with a commercial mortgage, you’re the owner of the property. And while you’ll still make monthly payments, you get to keep the property permanently once you repay the loan in full. Not to mention, you’re free to decorate and refurbish the building whenever you want.
Getting a commercial mortgage instead of renting a building also protects you from rising rent fees. Even if it’s a variable-rate commercial mortgage, these fluctuations in interest rates never even come close to the rental raises that landlords enforce.
Buying a property through a commercial mortgage can make you some capital gains, especially if the property’s value increases over time.
Easy to Get Out Of
If you decide that you no longer need the property, you can just sell it the following day. As opposed to commercial leases, there aren’t any time-consuming steps that you need to take to exit.
Shortcomings of Commercial Mortgages
Just like with any form of borrowing, commercial mortgages aren’t free of disadvantages. Here are some of the concerns associated with taking a commercial mortgage:
Requires a Deposit
One of the most significant drawbacks of this type of mortgage is that they require a deposit at the beginning of the contract. Such a large sum of money can set you back substantially and hinder the development of your business, especially if the lender asks for a large deposit.
One way to get around that is to get a personal loan with a value equivalent to that of the deposit. However, this can be risky since you’ll be increasing your debt even more.
High Interest Rates
Commercial mortgages usually have higher-than-average interest rates, as opposed to personal loans. This is simply because properties appreciate as time passes, as opposed to cash.
And since this is a business-related mortgage, lenders raise up the interest rates to ensure that borrowers are fully aware of what they’re doing and have a sustainable plan for the future of their business and the loan’s term.
It’s also worth noting that some commercial mortgages come with variable interest rates. These are a bit less predictable than fixed-interest commercial mortgages. Any rise in interest rates might put your company on the verge of bankruptcy.
Keep in mind that we’re only talking about secured loans here. Compared to unsecured loans, commercial mortgages have much lower interest rates.
Uncertain Market Conditions
Your property’s value may rise or fall depending on market conditions. If your property depreciates, you’ll lose capital, which can negatively impact your company’s financial situation.
Some business owners underestimate the maintenance costs of their new property, but they can add up pretty quickly. And the problem is that all of them will be covered by you, not the lender.
Maintenance costs shouldn’t be your only concern once you become a property owner. You also need to account for refurbishing costs unless you’re planning to work on hard concrete. Things like office furniture, decorations, and appliances are some of the things that you’ll have to pay for.
Commercial Mortgage Providers
Here’s a list of the types of lenders that offer commercial mortgages:
Niche lenders hold the advantage of having less strict eligibility criteria. Even if your business hasn’t started yet, you can still get a commercial mortgage from a specialist lender.
However, you’ll be required to present robust planning and forecasting reports to showcase how serious your business is. A certified accountant must also approve such paperwork for it to be legit.
Challenger banks will do all they can to sign you up for a commercial mortgage. For that reason, their eligibility criteria are often not that hard to overcome.
For instance, if your business had a credit file problem in the last few months or years, you might still get approved for a commercial mortgage.
High-street banks often impose the most vigorous requirements out of all other lenders. The good news is that their interest rates are very competitive. Not to mention, you might be able to get a higher mortgage value from a high-street bank than from a challenger bank or a specialist lender.
High-street banks use the property’s open market value for valuation, which ultimately means that your mortgage value will be higher.
Commercial Mortgage Requirements
Here are the general requirements needed to apply and get approved for a commercial mortgage:
- A bank statement that covers the previous 3 or 6 months
- Trading figures for the past 3 years
- Identity and address documents
- Tenancy or lease agreements
- The property must be valued
The prerequisites of commercial mortgages may vary from one lender to another. For example, some banks or lenders may request a business plan for the upcoming years. This gives the lender more confidence that you’ll be able to repay the loan on time.
How to Apply for a Commercial Mortgage
Once you prepare all the required documents needed to apply for a commercial mortgage, you’ll need to fill out the application form and the Asset and Liability form. You’ll also have to provide information about your business.
What Is the Difference Between a Commercial Mortgage and a Residential Mortgage?
There are two primary differences between commercial and residential mortgages: term and property value. Commercial mortgages typically have much longer terms that may last for up to 20 years. Additionally, the properties used to secure commercial mortgages are much more expensive than those used to secure residential mortgages.
Furthermore, commercial mortgages require larger down payments than residential mortgages. Another aspect to keep in mind is that residential mortgages usually have fixed interest rates, as opposed to commercial mortgages that can either have variable or fixed rates.
As for the mortgage features, you can quickly get an excellent residential mortgage if you have a high income. With a commercial mortgage, things get a bit different. Lenders often care more about how much money the property can generate regardless of your current income, especially if the property is projected to produce a large amount of cash every month.
When to Opt for a Commercial Mortgage Broker
Commercial mortgages have their share of fees, and even if your mortgage doesn’t get approved, you won’t get a refund for any of the fees you paid. Money isn’t the only concern here, though. You’ll be wasting time jumping from one lender to another until one of them approves the mortgage.
If your capital can’t withstand all of these fees, or if you’re short on time, then getting a mortgage broker would be the better way to go.
Mortgage brokers can locate the best lenders for your company’s current financial status, sparing you the effort of having to look it up yourself. You’ll also save time and money. After all, the fees of a mortgage broker are much less than those of a rejected commercial mortgage.
We would always recommend looking for a Broker who belongs to the National Association of Commercial Finance Brokers. Visit NACFB for more information.
Refinancing a Commercial Mortgage
Do you own a property for your business? You might want to consider refinancing or re-mortgaging the property to gain equity. Releasing equity allows you to invest in other areas of your business, like hiring more employees or buying new equipment.
Refinancing is simply replacing a mortgage with another one. In other words, you pay for a mortgage you already took to get enough money for a completely different mortgage.
Many businesses opt for this little financial loophole to improve cash flow to their capitals and maybe even get better interest rates.
Applying for a new commercial mortgage can be a good opportunity for you to get a better deal by introducing an improved financial situation and different valuation, giving the lender enough reason to drop down the interest rates.
Another scenario when refinancing might be a good idea is when you’re on a variable-rate commercial mortgage. By replacing your current mortgage with a fixed-rate mortgage, you can reduce the overall monthly expenses of your business and retarget your capital into more useful expenditures.
On a side note, refinancing a mortgage doesn’t happen overnight. For starters, you need to prepare a huge amount of financial paperwork, like balance sheets, forecasts, etc. What’s more, you’ll likely have to pay early repayment fees to settle your current mortgage.
It’s also worth mentioning that you need to consider the time required to go through the whole application process all over again.
Applying for a Commercial Mortgage With Bad Credit History
If your credit history is nothing to brag about, you might still be able to acquire a commercial mortgage, but the interest rates will likely be higher. A poor credit score is a red flag for any lender, making them trust you less with their money.
There are many things you can do to improve your credit score. For example, you can send 609 dispute letters to omit some negative items off your credit report. It’s also crucial that you settle any debts you didn’t pay off to increase your chances of getting approved for a commercial mortgage.
You can also get in touch with a trustful credit repair company, and they’ll handle all the legal work related to disputing negative credit items for you.
Commercial Mortgage Alternatives
If you think that the criteria needed to be approved for a commercial mortgage are unachievable, there are other alternatives that can help you buy a new property, which include:
Opting for a bridging loan can be a great decision if you’re planning on moving to a new house but don’t have enough funds to buy it immediately. Just keep in mind that bridging loans are more of a short-term solution. They’re only used when a business is preparing for more robust financing in the foreseeable future.
Personal loans are the most popular type of loans because they’re easy to acquire and have less strict requirements than other types. For example, you don’t need collateral to apply for a personal loan. You don’t even need to be a property owner in the first place.
However, keep in mind that personal loans usually have a limited value ceiling, making them an infeasible solution for businesses that need an expensive property.
The biggest advantage that short-term loans have is that you won’t have to commit to anything long-term. You never know how things will turn out in the upcoming years, so getting a short-term loan minimises your risk of failing to repay. However, they come with skyrocketing interest rates and fees that you might want to consider first.
To recap, a commercial mortgage can be an excellent choice for start-ups that need a place to run their businesses. However, it’s not risk-free; you’re going to be in debt for at least a few years, and you may not even be able to repay it in full.
Before applying for a commercial mortgage, make sure that you think about the whole thing from A to Z to avoid jeopardising your finances and getting yourself into legal disputes.