Commercial Mortgages – How Do They Work
In 2022, an increasing number of businesses exist more or less exclusively online inhabiting a rent-free, never-space without geographical constraints. On the other hand, many other businesses still need one or more physical premises in order to do what they do and in order to acquire these premises, many need to raise financing in the form of a commercial mortgage (otherwise known as a commercial real estate loan).
In this post we are going to take a close look at what a commercial mortgage is. We will look at how mortgages for business work, the feasibility of commercial mortgage refinance and will also examine what commercial mortgage lenders can offer.
What Is a Commercial Mortgage?
Put very simply, a commercial mortgage is a mortgage which a business or company uses in order to buy a business premises. Basically, a mortgage lender will advance the money for the business to buy a property and the loan is then secured against the property title.
Whilst commercial mortgages are very similar to residential, home buying, mortgages there are some notable differences which we shall explore.
Why Might a Business Need a Mortgage?
Any company that wants to own its business premises but does not have the cash to buy it may wish to obtain a commercial mortgage. With rents rising and real estate becoming increasingly scarce, ‘owning the workshop’ is a great way for a business to reduce its long term costs, and also to secure its own future.
For example, an insurance company that wishes to buy its office block may need a commercial mortgage to facilitate the phrase, as might a successful restaurateur sick of paying high, city centre rents to landlords.
Other examples include developers buying land on which they intend to build a shopping mall, and even housing associations looking to buy residential homes with the intention of then sub-letting them to individuals.
In some cases, businesses may be able to buy residential properties to use as accommodation for employees if they can find a willing lender. However, in these cases it may prove more cost effective to find a residential mortgage lender who is willing to grant the mortgage in the name of the company.
Finally, a business can also remortgage a property it already owns, and use the advance money however it wishes.
Who Can Get a Commercial Mortgage?
Commercial mortgages are suitable for established businesses looking to expand or restructure. Newly formed businesses and start ups on the other hand, will often struggle to find a willing lender until they can demonstrate 2 years of trading and credit history. Monthly commercial mortgage payments can be very high as lenders want to be sure that the borrower can afford to service them.
Commercial mortgages are usually awarded to limited companies and corporations, but other company structures such as trusts may also be eligible. Sole traders wanting to buy a business premises may struggle to obtain a commercial mortgage unless they first incorporate and form an LLC.
How Mortgages For Business Differ From Residential Mortgages
While the basic concepts for commercial and residential mortgages are broadly the same, the realities are actually quite different.
Firstly, commercial mortgage lenders tend to assess each application on a case by case basis rather than relying on a set lending criteria. This reflects the complexities of business and the fact that commercial properties are a lot harder to value, and sell than residential properties.
● Commercial Mortgage Lending + Loans
Next, a much larger deposit is needed to obtain a commercial mortgage than a residential one. Many residential lenders will accept a deposit of 5% of the property’s value, whereas commercial lenders may seek a deposit between 20% – 40%; in many cases businesses may even need to obtain a separate loan just to be able to raise the deposit for a mortgage!
● Commercial Mortgage Interest Rates
Interest rates are also higher on commercial mortgages than on residential properties. As a minimum, a commercial borrower can expect to pay 0.5% – 1% more although some commercial mortgage lenders charge interest of up to 20%.
● Commercial Mortgage Repayment Terms
Finally, repayment terms are often a lot shorter – whereas residential mortgages are often offered over 20 – 30 years, residential mortgages tend to range from 5 – 20 years.
What Commercial Mortgage Lenders Do When a Borrower Defaults
A commercial mortgage is secured against a business premises. The premises are collateral for the loan so in the event of a default, the lender has the right to issue foreclosure proceedings, repossess the property and sell it in order to repay the debt.
This can sometimes really exacerbate problems. For example, a temporary cash flow problem may mean a business is unable to maintain its monthly payments, but if the lender responds by repossessing the office, then the business is rendered completely unable to trade and has no chance of ever resolving these temporary cash flow problems.
Of course, in reality lenders are quite reluctant to repossess properties, will exercise a great deal of forbearance and only issue proceedings in what they deem to be hopeless cases.
Commercial Mortgage Refinance
If a business is fortunate enough to own a property that has equity in it, then it may be able to obtain a commercial remortgage. In these situations, the lender is not advancing the money in order to buy the property but for other reasons such as paying off debts, buying new equipment, or even acquiring another business.
The advantage of remortgaging an existing commercial property is that it can allow a business to borrow a substantial sum of money, at relatively low interest rates. The downside is that the property is then at risk of being foreclosed if the business cannot maintain the repayments.
Using an SBA Loan To Buy Property
In some cases, a business may be able to obtain an SBA (Small Business Administration) loan, for the purposes of buying commercial premises. The SBA—7(a) loans and 504 both have provisions for lending to buy property and both have a limit of $5 million which will be more than enough in many cases.
As we have seen, a commercial mortgage is simply a mortgage for business. Indeed many commercial mortgage lenders also offer residential mortgages even if the lending criteria is quite different between the two.
If a business is looking to buy a new premises, then it will probably need to seek commercial mortgage lending + loans to fund the purchase. On the other hand, a business that already owns a property may find commercial mortgage refinance an excellent way to raise low cost borrowing for expansion or other business needs.