The definition of a commercial mortgage is any loan secured for a property that is a commercial premises, and therefore not your main place of residence. Below are some of the other most common terms associated with business mortgages.
Assets and liabilities statement
- A statement that shows the incomings and outgoings of the company, which will be used to assess eligibility for a commercial mortgage. Assets include current ownership of buildings, equipment, land and accounts receivable, while liabilities include accounts payable, wages and taxes.
- Other eligibility evidence includes at least two months of bank statements and three years of audited or certified accounts.
The first month in which a financial instrument begins; eg, when the mortgage starts.
- A short-term funding option that ‘fills the gap’ often in the case of emergency such as during an auction where a mortgage is needed quickly. They can usually be arranged quickly, to be used to fund the purchase of commercial or residential property or for other purposes.
- A bridging loan might also be used in cases where a ‘traditional’ mortgage is unavailable at that time. For example, a client might want to purchase a building with retail potential but in a poor state of repair, meaning that he cannot secure a mortgage. Instead he secures a bridging loan to complete the purchase at auction, and then improves the properties. Within a few months they are fit for use and he gains a tenant, meaning that he can secure a mortgage and repay the bridging loan.
- A bridging loan can also be used by wealthy borrowers who want a straightforward loan for property purposes and do not want to apply for a mortgage.
Buy to let mortgage
- A mortgage for a property intended to be rented out, either as living accommodation or for business premises. In such cases a lender will use criteria such as deposit size and credit rating – as per a residential application – but also the projected income from rent for the property.
- Some lenders will insist that the rental income is at least 125% of the mortgage payments. Buy to let mortgages may require a higher deposit of at least 25% but possibly as high as 40% or more, alongside higher interest rates. The stricter conditions reflect the risk factor of the property being left unoccupied for any period of time, and hence no income.
Newer banks that may not have a high street presence, but may also have different criteria for lending. Many specialise in finance for SMEs, offering short-term property loans and commercial mortgages with DSCR requirements that may be lower. They may even consider applications for companies with credit history issues. However, they might be more expensive, with higher exit fees should you wish to transfer to another mortgage.
Commercial mortgage legal fees
The costs of organising and administrating the mortgage, to be paid to estate agents, solicitors and conveyors. These fees could include:
- Lender arrangement fee
- Valuation fee
- Legal fees to the lender looking after the property and the borrower’s own solicitor
- Broker fees
DSCR (Debt Service Coverage Ratio)
- A ratio that gives a measure of the cash within the company that enables you to pay debts. It is calculated by dividing the income of the company by the total debt.
- For example, if a company has an income of £1.5m and debts of £1m, the DSCR is 1.5. If the number is less than 1, the debts are greater than the income, and this can be problematic.
- Lenders will look for a ratio high enough so that a mortgage could still be paid in the event that income drops, and might take future projected income as evidence if they have been certified by an accountant.
First and second charges
- A first charge is your main, priority mortgage, while a second charge refers to borrowing for any other buildings you wish to buy such as commercial premises.
- An example of a typical second charge loan is a bridging loan.
- Typically, the equity in the first charge is the security for the second charge loan.
Fixed rate mortgage
A mortgage type where the interest rate remains the same throughout a set period. For example, 5% interest rate fixed for three years. Other mortgage types include tracker and variable rate mortgages.
- A leasehold sale exists where the buyer owns the home but not the land it is built on; this is effectively rented from the leaseholder. In a freehold sale the homeowner also owns the land.
- Leasehold purchases have not been a problem until this century, when leaseholders have raised the prices of annual rent (Direct Line estimates an average of £371), and ratcheted up purchase costs for the lease.
- In some cases the property owner may need to apply to the freeholder for permission to change commercial premises (eg extending), on top of applying to the local authority for planning permission.
The London Interbank Offered Rate is an average of interest rates estimated by leading banks in London, usually used if the banks charge each other for short term loans. It’s also used as a base rate for many tracker mortgages, where the eventual interest rate is ‘LIBOR plus X%’.
LTV (Loan to Value)
- The Loan to Value ratio; a percentage which expresses what proportion of the cost of the property is being borrowed. For example, borrowing £75,000 as a mortgage for a £100,000 property represents a 75% LTV, with the other £25,000 being supplied in the form of a deposit by the buyer.
- Some lenders will fund an 80% commercial mortgage, subject to the borrowing company’s past trading performance, but for a brand new business they may only offer 50% LTV.
- The usage of the building could be important; for example, if you decide to change the use of a building from owner-occupied (ie your own business) to commercial buy-to-let (ie you move out and let several rooms as individual offices) the risk factor increases for the lender, and you may need a higher deposit for a mortgage.
Your personal income might be taken into account when applying for a mortgage with the aim of becoming a first-time landlord, with a common benchmark of £25,000. Your income, plus your likely rental income from the property, will both be assessed.
OMV (Open Market Value)
The price of a property that you might expect to receive if you had time to look at multiple offers, as opposed to Forced Sale Value.
- One of the three common reasons that a buyer would want a commercial mortgage; the owner buys the property and operates the business within.
- The two other common scenarios are residential buy to let for professional landlords, or commercial buy-to-let, where a buyer takes a property with the aim of renting it out as premises for other businesses.
Some major banks will not consider a commercial mortgage without planning permission in place, if you’re creating a business in premises that will need alteration. However, challenger banks and niche lenders may consider an application without planning permission.
- The point at the end of a term where new arrangements are made. This might include a change in the length of the new term, or a difference in the interest rate.
- If you remortgage before the term has finished you may have to pay an exit fee to the current lender.
Generally, the premises on which you are taking a mortgage count as some form of security; many lenders look at the remaining equity in the building, taking into consideration what it would be worth if you had to sell immediately (Forced Sale Value) and any liabilities or assets the business has.
Stamp Duty Land Tax (SDLT)
A tax payable on properties that cost £150,000 or more, as opposed to £125,000 for residential property. SDLT is payable by the buyer for freehold properties and is taxed at 2% of the portion of a purchase between £150,001 and £250,000, and 5% on anything above £250,001. Some leases may also levy SDLT.
The length of the mortgage. While domestic mortgage terms tend to last between 2-5 years (until remortgaging), commercial mortgages can last up to 25 years, which might confer a more favourable interest rate.
A mortgage interest rate which varies based on the Bank of England Bank Base Rate or LIBOR. The variable rate depends on the base rate at the time the mortgage is taken out as compared to a tracker which ‘tracks’ the base rate as it changes.