Some of the many ways in which commercial and buy-to-let mortgages differ from residential mortgages are the factors that determine how much you can borrow.
Key to this distinction is the source of the funds you will use to repay the mortgage debt. With a residential mortgage, this will more often than not be your personal income.
It is generally assumed that a commercial mortgage, on the other hand, will be covered by the rent you make from your property.
Enter debt-service coverage ratio (DSCR), a calculation used by commercial lenders to determine whether your cash flow is enough to cover your mortgage repayments.
Use the commercial mortgages calculator once you have a rough DSCR figure to get indicative commercial finance figures.
How DSCR is calculated
DSCR determines the minimum rental income required to meet your mortgage repayments by an acceptable margin. It is expressed as a percentage of the interest aspect of your mortgage repayments at a particular interest rate.
For instance, a lender might ask for rental cover ‘at 150% of the pay rate’. The pay rate refers to the interest rate payable during the initial deal period of the mortgage, and 150% is the percentage of the interest aspect of your repayment that your rental income must meet.
So if you took out a £600,000 commercial mortgage with an introductory rate of 5.6%, your monthly rental income would need to be half again as much as the monthly mortgage interest repayment of £2,800; i.e. £4,200.
Lenders don’t always use the pay rate; many use a nominal rate that they set as a standard for all their customers, and it is common for lenders to use the higher of this or the introductory rate of the mortgage you are applying for.
Similarly, not all lenders will use the same DSCR figure. On the high street, you might see buy-to-let lenders asking for 130% and commercial lenders asking for 180% or even 190%. Some lenders will go far lower.
DSCR for ‘premium’ properties
In certain parts of the UK (prime Central London being the chief culprit), property prices are simply far too high for rental income to achieve the desired debt coverage in most cases. However, these areas are still desirable to investors due to the properties’ ability to accrue and hold value.
As such, some lenders will make exceptions for borrowers buying in certain areas. They will agree to lower their DSCR, sometimes to as low as 110%, in premium areas – but they will often also lower their maximum LTV (loan-to-value) ratio, meaning that you will need to pay a larger deposit in exchange.
DSCR for owner-occupiers
Of course, you may be buying a commercial property to run a business of your own, rather than rent out. The principle of DSCR remains the same, but instead of instructing a rental valuation, your lender will usually examine your ‘adjusted net profit’.
A general indicator of the profitability and debt-servicing capacity of a company, adjusted net profit is simply net profit plus certain costs added back in (‘add-backs’). Add-backs tend to be non-cash expenses such as amortisation, depreciation, interest and tax. Some cash expenses might also be considered, as might directors’ and owners’ salaries and other rewards.
Planning your application
As lenders’ criteria vary widely, it is important to know that you’re applying to the right one in order to give your application the best chance of success. Working with a specialist broker such as Commercial Trust will give you access to a wide range of options. Call us today or request a quote to find out how we can help you find the right commercial mortgage.