Commercial mortgages are used to finance the purchase of business premises and have terms that can vary from less than three years to 20 or more. They are secured on the property being financed via a first charge. Conventional commercial mortgages usually require repayments of capital and interest, although in some cases interest-only products may be available.
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The Informed Funding two-minute guide: Commercial Mortgages
- How long is a commercial mortgage term?
Commercial mortgages taken out to purchase business premises can run for between three and 20-plus years. It may be a long-term loan of 10-20 years taken out when the property is purchased, or it may be a much shorter-term deal used to refinance an existing mortgage. In all cases, however, the loan will be secured by a charge on the property concerned and access to it will be determined by the value of the property, the proportion of equity that the borrower is able to contribute and the performance and prospects of the business that will be responsible for servicing the debt. Commercial mortgages are mainly provided by mainstream banks and building societies although a wide variety of specialist lenders are also active in this market.
- How does the application process work?
As with any mortgage application, the lender will assess both the value of the property that you plan to purchase and the ability of your business to repay the loan. The maximum loan to value ratio available varies but is generally around 70% and rarely higher than 80%. You will therefore have to put up the remainder as equity. If you are unable to do this, you may have to use the available equity in another property you own, an investment portfolio or insurance policy as security for any lending above the LTV ceiling. You will have to provide detailed financial information on your business and a business plan showing projected revenues and profits in order to demonstrate that it will be able to repay the loan.
- Do I have to take out a repayment mortgage?
Commercial mortgages can be repayment or interest-only, although it has generally become more difficult and expensive to borrow interest-only in recent years. If your lender offers an interest-only deal, it is very likely to insist that you have an investment plan or insurance policy in place that will enable the capital to be repaid at the end of the term.
- What rate will I have to pay?
Interest rates on commercial mortgages are set on a deal-by-deal basis. Your rate will depend on a wide variety of risk factors including the size and profitability of your company, its credit history, the size of cash deposit, the mortgage term and so on. Rates can vary quite widely but commercial mortgages are more expensive than residential mortgages because they are regarded as riskier.
- Are fixed rates available?
Most commercial mortgage rates are variable, with the interest rate expressed as a premium over a so-called “reference rate” known as Libor. So you might pay Libor plus 4.5%, for example, the actual interest rate rising and falling as Libor fluctuates. You may be able to fix your rate by buying a “swap” that converts the variable rate you have been offered into a long-term fixed rate, although “swaps” have become extremely controversial in recent years and you should seek independent professional advice before making a commitment. It is also possible to borrow at a fixed rate without purchasing a swap, particularly from some alternative finance providers, although these deals tend to last no more than five years and are mainly used to refinance an existing mortgage rather than to fund the initial purchase.
- What fees and costs are involved?
Aside from the interest charges, you should expect to pay an arrangement fee of around 1%-2% of the amount you are borrowing. You’ll also have to meet the cost of an independent valuation as well as your own legal fees and those of the lender. You may also have to pay a redemption penalty if you want to repay the mortgage before the term has expired.
- Need to know:
- You can obtain a commercial mortgage to buy a leasehold property but there will need to be enough time left to run on the lease. A typical minimum is 70 years.
- A key advantage of buying your business premises with a commercial mortgage is the opportunity to benefit from the capital growth in the value of the property, which over time can significantly strengthen your company’s balance sheet.
- It is possible for your pension fund to own or lend against your business premises and this may offer considerable tax advantages. However, you should seek professional advice before you take this route.
- Mortgages will appear in the accounts with the liability split between the long term and short term elements.
- The details of any assets provided as security on the mortgage are required to be disclosed in the accounts.
- Interest payments will be allowable expenses for tax purposes if taken out for the purposes of purchasing an asset used in the day to day trading activities of the company.
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