What is a Commercial Mortgage?

A commercial mortgage is a type of loan specifically designed for businesses looking to purchase, develop, or refinance commercial property. Unlike residential mortgages, which are intended for personal homes, commercial mortgages are used to fund properties that are primarily for business activities. These could range from offices, warehouses, and retail spaces to mixed-use buildings that combine both residential and commercial purposes.

For business owners and investors, understanding how commercial mortgages work is essential for making informed decisions about property investments. This article will explore the key aspects of commercial mortgages, including how they differ from residential mortgages, the types of properties they can fund, the process for obtaining one, and the potential benefits.

Key Differences Between Commercial and Residential Mortgages

While both residential and commercial mortgages are loans secured by property, there are several important distinctions between them.

1. Purpose and Property Type:
   • A residential mortgage is used to purchase a property where the borrower intends to live, such as a house or flat.
   • A commercial mortgage, on the other hand, is for buying property that will be used for business activities. This can include offices, shops, industrial units, or even land for future commercial development. There are also part-commercial mortgages, which cover properties used for both residential and commercial purposes, such as a shop with a flat above it.
2. Loan Amount and Property Value: Commercial properties tend to have higher values than residential ones, which means the loan amounts for commercial mortgages can be significantly larger. However, this also depends on the property’s income-generating potential, especially if it’s an investment property that will be rented out.
3. Risk and Interest Rates: Lenders view commercial mortgages as riskier than residential ones because business success can fluctuate, affecting the borrower’s ability to make repayments. As a result, commercial mortgage interest rates tend to be higher. The terms of commercial mortgages are also less standardised, meaning interest rates and fees can vary greatly depending on the lender and the specific deal.
4. Regulation: Residential mortgages in the UK are regulated by the Financial Conduct Authority (FCA), providing protections for individual borrowers. Commercial mortgages, however, are not FCA-regulated, giving lenders more flexibility but placing more responsibility on the borrower to fully understand the terms and conditions.

Types of Properties and Uses for a Commercial Mortgage

A commercial mortgage can be used to finance a wide range of property types, including:

• Offices: For businesses needing workspace for their employees.
• Retail Units: Shops or shopping centres where products and services are sold to the public.
• Industrial Buildings: Warehouses, factories, or other properties used for manufacturing or storage.
• Hospitality Venues: Hotels, restaurants, and pubs.
• Mixed-Use Properties: Buildings that combine commercial space with residential units, such as a flat above a shop.
• Land for Development: In some cases, businesses can use a commercial mortgage to purchase land for future commercial construction.

In addition to property purchases, commercial mortgages can also be used for property development, renovation projects, or even to refinance an existing commercial property loan.

How to Get a Commercial Mortgage

Securing a commercial mortgage requires a more detailed application process compared to residential mortgages. Here are the general steps involved:

1. Determine Your Financial Situation

Lenders will want to review the financial health of your business, as well as your own personal finances in some cases. You’ll need to provide several key documents, including:

• Recent bank statements and financial records.
• Tax returns for the past few years.
• Performance figures and financial forecasts for the business.
• Details of your partners or directors, if applicable.

2. Research Lenders

Unlike residential mortgages, commercial mortgages are less standardised, and lenders may offer different terms depending on the type of business, the property’s use, and the financial risk involved. A mortgage broker can help you navigate the options and find a lender that fits your needs.

3. Deposit Requirements

Commercial mortgages usually require a larger deposit than residential mortgages, typically ranging from 20% to 40% of the property’s value. The exact deposit will depend on the perceived risk of the business, with high-risk industries, like hospitality, sometimes requiring higher deposits.

4. Interest Rates and Repayment Terms

Commercial mortgages can offer a mix of fixed or variable interest rates, and repayment terms typically range from 3 to 25 years. The term of the loan often depends on the value of the property and the amount of the loan. Some lenders also offer interest-only mortgages, where you only pay the interest during the loan term, with the principal repaid at the end. However, this carries the risk of not owning the property outright unless the loan is fully repaid.

5. Legal and Regulatory Considerations

When applying for a commercial mortgage, the lender’s solicitor will perform an extensive due diligence process, which can be more complicated than with residential mortgages. This might include assessing the property’s legal status, tenancy arrangements, and compliance with local planning regulations. If the loan is substantial, lenders may also require a personal guarantee (PG), especially from directors of smaller companies. In such cases, you’ll need to obtain independent legal advice before agreeing to the guarantee.

Benefits of a Commercial Mortgage

There are several reasons why businesses choose commercial mortgages over other forms of financing, such as leasing:

1. Ownership of Property: A commercial mortgage allows businesses to own their premises, giving them more control over the property and freeing them from rising rental costs. Owning the property can also provide long-term financial benefits, as the property’s value may appreciate over time.
2. Flexibility: Lenders often offer more flexible repayment terms for commercial mortgages, allowing businesses to tailor the loan to their specific financial situation. Borrowers can choose between fixed and variable rates and, in some cases, opt for interest-only repayment plans.
3. Investment Potential: Commercial mortgages are not only for owner-occupied businesses; they are also a popular option for property investors who want to generate income through rent. The yield from renting out commercial properties can sometimes be higher than residential rents, offering attractive returns.
4. Equity Release: Businesses that already own property can use a commercial mortgage to release equity, providing access to capital for further investments or business growth.

Costs to Consider

When taking out a commercial mortgage, it’s important to budget for additional costs, such as:

• Valuation and survey fees.
• Legal fees for both the borrower and the lender.
• Arrangement fees, which are typically a percentage of the loan amount.
• Insurance costs, especially for more expensive properties.

Final Thoughts

A commercial mortgage can be a powerful tool for businesses seeking to invest in property, whether for operational use or investment purposes. While the process can be more complex than obtaining a residential mortgage, the potential benefits – including ownership, flexible terms, and long-term financial gains – make it an appealing option for many business owners.

By doing thorough research and working with experienced professionals like brokers and solicitors, businesses can navigate the commercial mortgage process with greater confidence and secure a financing solution tailored to their needs.