Interest-only commercial mortgage guide

If you are planning to invest in a business premises with a commercial mortgage.you have the option of interest-only or capital repayment terms.

This guide describes what these two options are, the benefits and disadvantages of each and which type of applicant lenders will issue these terms to.

What is an interest-only commercial mortgage?

Let’s first be clear on what a commercial mortgage is

It is a secured loan that you can use to buy commercial properties for business purposes. Investors can also use this mortgage to buy a commercial property to then rent to a business.

You can use this mortgage to buy any commercial property, from a warehouse to a restaurant. You can also use this mortgage to buy a mixed-use property. This is a part commercial and part residential property, commonly referred to as a ‘semi-commercial’ mortgage.

UK lender’s commercial mortgage interest rates are typically higher than residential mortgage rates. They are subject to change in the same way all mortgage rates are. For the latest interest rates, you can use our commercial mortgage calculator.

The loan term is usually between 3 to 25 years, but can be longer depending on your lender.

What is an interest-only commercial mortgage?

The standout feature of an interest-only commercial mortgage is that you do not repay the cash lump sum of the loan, just the interest the lender charges for borrowing that money.

This means that, whilst you make monthly payments over a set period, at the end of the mortgage term you will not own the property.

At this point you can either remortgage to new deal and continue paying on an interest only basis (or change to capital repayments, which do pay down the cash lump sum), sell the property to repay the lump sum, or use another source of funds to pay back the lump sum.

Why choose this mortgage?

Below are the advantages of this mortgage type:

Lower monthly payments

The main benefit of this mortgage is the lower monthly payments. An interest-only commercial mortgage compared to a capital repayment mortgage, on a like-for-like basis, would result in lower monthly mortgage payments. This is because you are not repaying the cash lump sum, just the cost of borrowing.

You can use a commercial mortgage calculator to calculate illustrative monthly interest payments. The calculator also allows you to compare how much you would pay if you opted for interest only terms versus capital repayment terms.

Monthly income

Interest-only commercial mortgages are a great option if you are investing in a property you are letting out. You can use the rental income to cover the monthly interest payments. The remaining profit gives you an income stream, which you can use for a range of purposes.

You might opt to save this money up to invest in more properties. If you are considering this strategy, take a look at our guide to building a property portfolio.

Disadvantages

While interest-only payment terms have benefits, there are also some risks:

Repay lump sum at end of term

The main downside is the need to repay the cash lump sum you borrowed at the end of the term, which remains outstanding at the end of the term, if you want to own the property.

Need for stable income

As with any commercial mortgage, you will need to have a stable income to meet your monthly interest payments. This can be difficult for owner-occupiers whose business income fluctuates.

Investment-only landlords will face problems if their commercial tenants miss their rental payments, which is why conducting thorough due diligence on prospective tenants is essential.

In a worst case scenario, you can evict a tenant for non-payment of rent, but it can be a costly and stressful process. This again underlines the importance of finding a tenant who will not struggle with paying the rent.

Risk of repossession

If you cannot keep up with mortgage payments, your lender make retake possession of your property to sell it, in order to recoup the remaining debt. This is always a last resort, but can happen.

If you are renting out the property, this is likely to mean your tenants would be evicted.

If you are running your own business from the property, you are likely to have to move out, so the loss of the property has two implications for you.

Eligibility criteria

The eligibility criteria for interest-only commercial mortgages versus capital repayment mortgages are the same, but, commercial mortgage criteria as a whole varies between lenders.

As an owner-occupier (where you want to buy a commercial property to run your own business from it) lenders tend to prefer applicants to take capital repayment terms.

High street lenders in particular typically lend on a capital repayment basis.

If you are buying as an investor and will only be letting out the building to business tenants, there are more options with either interest-only or capital repayments.

In general, lenders will look at these eligibility factors:

Deposit

Most commercial mortgage lenders will need a minimum of 25% deposit to approve your loan. The deposit amount will vary depending on the lender's requirements can be as much as a minimum of 40% of the property value.

Regardless of the maximum loan to value a lender will offer, a larger deposit will reduce the risk to lenders. This may mean that you can secure a lower mortgage interest rate, from the array of products on offer in the marketplace.

As a specialist commercial mortgage broker, we can help you get the best possible deal from a wide range of commercial lenders.

Rental income

If you are investing in a commercial property to rent it out, the amount you can borrow will depend on the rent you can generate from it.

This is because the lender sees the rent as the way the mortgage payments will be made.

Business viability

If you are intending to run your own business from the security property, lenders will look at the financial health of your business, to gauge how much they will lend you.

They will ask for business plans, financial projections, and historical financial records. A business that is making good profits is more likely to get a commercial mortgage, as the business income is the way the mortgage payments will be made.

Exit strategy

When you are borrowing on an interest-only basis, you will need to provide the lender with a clear and credible exit strategy. This is how you plan to repay the loan amount at the end of the term. This could be through the sale of the property or refinancing.

Credit rating

Your credit rating is a factor that lenders will consider. A good credit score will show that you are likely to meet your mortgage repayments. This means there are likely to be more lenders prepared to issue you with a mortgage.

While not as easy, you can still get a commercial mortgage with bad credit, because there are lenders who specifically want to work with clients in this position. The risk to the lender is greater, so mortgage interest rates tend to be higher to take this into account.

Property

Lenders need to ensure the estimate provided for the property value is correct. They will appoint a valuer to establish this. If the value of the property is lower than the amount put on the application, there would be a risk of financial loss to the lender.

Applying for a mortgage

We outline the application process for an interest-only commercial mortgage:

Choosing the right lender

It is sensible to compare different lender products to find the best mortgage for your needs. When comparing, consider the offered interest rates and loan terms. You should also consider the reputation of the lender and their customer service standards.

A commercial mortgage broker can help you to find a lender that matches your needs. Brokers have access to a wide range of lenders who offer interest-only commercial mortgages.

With such a wide range of options, it would be almost impossible to assess all the options available to you as a consumer. What’s more, some lenders will only offer mortgages to applicants who apply using an intermediary (e.g. a broker). If you were to discount these options, you might not end up with the most cost effective outcome and end up paying more per month on your mortgage.

Documentation and application process

If you are an owner-occupier (you intend to run your business from the property) lenders will check the financial situation of your business when you apply for a mortgage. This is to assess your ability to meet monthly interest payments.

You will need to provide business financial documents to the lender. This can include accounts, cash flow forecasts, and your business plan.

If you are a commercial property landlord, who intends to let the property out, lenders will need personal financial documents.

Other standard documents for a commercial mortgage are:

• 2 years business accounts (owner-occupiers only) or 2 years personal tax returns (investment only)
• 3 months bank statements
• Statement of assets and liabilities
• Details of all owned properties (your home, and any other residential and commercial property)
• Proof of deposit (purchase only)

The next step in the application process is a property valuation. The valuation is a check made on behalf of the lender, to ensure the property is worth the amount stated on the mortgage application.

Where a property is ‘down-valued’, the lender will either offer a lower loan amount, or if the loan is below their minimum, could withdraw the offer to lend completely.

A commercial mortgage broker can be a great help in this scenario, because they can use all the background information they have about your case to look for an alternative lender.

However, if all goes well, the steps after the valuation are as follows.

You will receive a formal offer letter if the lender approves your application. This letter details the conditions of the loan. This includes the loan amount, interest rate, loan term, and any extra fees.

Conveyancing solicitors will do all the legal work to transfer the property into your name.

Lastly, the mortgage funds are paid out.

Managing a mortgage

It is important to manage your mortgage to avoid any penalties.

We highlight a few tips for doing this:

• Make timely monthly interest payments: Paying interest on time is important to avoid any penalties on your credit profile. If you miss a payment you will still owe it and that extra month will be added to the end of the term, which will increase the overall interest you are charged. Missed mortgage payments on your credit profile can impact your ability to borrow in the future, on a mortgage, or any other type of borrowing.
• Monitor mortgage trends: If mortgage rates are experiencing significant changes, up or down, it is useful to be aware of this as you approach you renewal date. Refinancing at an opportune time can make a big difference to the interest rate you secure. Commercial Trust sends updates via email on this and other industry news, you can sign up for free here.
• Review your mortgage at the renewal date: Explore any opportunities to refinance your mortgage once you are nearing the end of the initial rate period. This could save you money, or you may be able to release equity for other investments.

Find the best commercial mortgage with Commercial Trust

Secure the best commercial mortgage from a wide range of lenders, with Commercial Trust’s mortgage brokers.

Commercial Trust is an independent specialist mortgage broker with access to a wide range of lenders in the UK. We will search for a lender that suits your business or investment needs. Our team of expert brokers will guide you through the application process and help you secure a great deal.

Contact us today to discuss a commercial property mortgage.

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