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A Guide to Small Business Loans & Mortgages
Commercial mortgages are offered by lending institutions such as banks and building societies. There is a range of commercial mortgage options open to you - providing you meet the lenders' criteria. Some lenders will consider, and may accept, applications where there is an adverse credit history, however the majority of lenders require your business to be creditworthy. Commercial mortgages can be used for a variety of purposes, for example the purchase of business premises, expansion, residential and commercial investment or property development. Some uses or business concerns may be excluded or have restrictions placed on them by the lender. You will normally be required to make monthly, quarterly or yearly repayments depending on the scheme you select. Below is a quick and easy guide to commercial mortgages.
WHICH MORTGAGE?
Depending on your personal circumstances and business status, you can choose whether to finance your commercial venture with a commercial mortgage or a re-mortgage for business purposes. If you choose to opt for a commercial mortgage the premises you fund will act as security for the lender and the lender will therefore have a legal charge over that property. In the event of non-payment the property can be repossessed and sold as a means of repaying the outstanding mortgage balance. A commercial mortgage provides you with access to capital with repayments designed to minimise the effects on your cash flow.
If you opt for a re-mortgage for business purposes you are re-mortgaging your residential property to fund your commercial venture. The lender will have a legal charge over your home and it will act as security in the event of non-payment. Your home is therefore at risk if you do not keep up the repayments of the mortgage secured on it.
Underlying Base Rates
Lenders will offer schemes with a variety of different base rates. The base rate is simply the underlying rate upon which the interest rate offered to you is based. The most commonly used are:
LIBOR (London Inter-Bank Offered Rate)
LIBOR is the rate of interest most commonly used as a reference point in calculating floating rate interest payments. It is calculated by taking the average of the rates of interest which an agreed selection of major London Banks are charging for lending money to each other. A LIBOR level can be obtained for each of the major lending periods available in the money market, i.e. one month, three months, six months, and twelve months. Our commercial mortgage finder displays schemes based on the 3 month LIBOR rate.
Standard Variable Rate (Lender Base Rate)
The basic mortgage rate that lenders offer is the standard variable rate (SVR). The SVR generally moves up and down according to Bank of England base rate changes.
Bank of England Base Rate
The interest rate is based on the Bank of England base rate, and this may rise or fall in accordance with changes in the market. The Bank of England base rate is reviewed on a monthly basis and may stabilise for long periods.
Gilts
The rate is calculated on the gross redemption yield on an equivalent dated medium or long-term gilt, before adding the margin. Our commercial mortgage finder displays schemes based on 3 month gilts.
Finance House Base Rate (FHBR)
This is the base rate published by the Finance and Leasing Association at the start of every month. It is calculated by taking an 8 week moving average of the three month LIBOR rate and rounding the result up to the nearest half of one per cent. FHBR is used as a base rate on variable agreements.
Margins
Each customer will have a margin added to the applicable base rate, which varies depending on the transaction involved. Lenders quote their margin range on each scheme they offer, for example 1% - 5% above base rate. This means that you will have a minimum of 1% and a maximum of 5% added to the base rate and the sum of these is the rate you will pay.
e.g. Base rate = 4%
Margin offered = 3%
Your rate = 7%
Rate Types
The majority of commercial mortgage schemes have variable rates. Put simply, this means that your interest rate will fluctuate in accordance with any changes in the underlying base rate. Your rate may rise or fall, and the effect of this is passed on to you in your monthly repayments. The rate may be stable for long periods of time, however you should be prepared for increased monthly repayments in the event of a rise in interest rates.
If you would prefer the security of fixed repayments you can opt for a fixed rate scheme. This is where the interest rate is fixed for an agreed period of time. The benefit is that your repayments will not fluctuate. It is common for lenders to offer rates fixed for a period of 2 to 5 years, but shorter and longer periods can be found in the market. At the end of the fixed rate period the rate will normally revert to the lender's prevailing standard variable rate (SVR).
Lenders also offer capped rate mortgages. This is where the rate you pay at the outset is normally the Society's current standard variable rate. This is guaranteed not to rise above a pre-set ceiling, or cap, for an agreed period of time. During this agreed period your rate may fall if interest rates are reduced. At the end of the capped rate period, the prevailing standard variable mortgage rate will apply.
Cap and collar mortgages work like capped rate mortgages but if rates fall there is a floor (or collar) below which your rate cannot fall. Like the capped rate mortgage, at the end of the agreed period the standard variable mortgage rate will apply.
Typical Rates
The exact interest rate you are offered will be based on an assessment of your application, the type of security or business and your financial standing. Most lenders consider applications on an individual case-by-case basis. The information we show on our commercial mortgage finder is a guide only and the exact terms offered to you may vary from those quoted. We display typical rates to provide an indication of the rate you may receive based on the underlying base rate and the margins quoted.
Repayment Methods
There are essentially two methods of repayment, which can then be broken down into different options:
Repayment only (capital and interest mortgage)
Interest only (ISA, pension, endowment or bullet repayment mortgage)
Repayment Only
Your repayments consist of repaying the capital amount borrowed together with the accrued interest. On your mortgage statement you will see that the amount borrowed decreases throughout the term.
Advantages
At the end of the term, you can be confident that the total amount of the mortgage has been repaid.
Overpayments and lump sum payments can be made into your mortgage account reducing both the interest and the capital.
Disadvantages
There may be financial penalties for making lump sum/overpayments. In the early years of a repayment mortgage the majority of the repayment is interest rather than capital.
Interest only
With this type of mortgage, only the interest is paid off with each mortgage payment. The borrower is also required to take out an alternative repayment vehicle such as an ISA, pension plan or endowment policy. The most important feature of an interest-only mortgage is that the repayments are not used to clear any of the outstanding capital balance. As a consequence it is important that the payments into the repayment vehicle are maintained otherwise it will not be possible to repay the mortgage at the end of the term.
Endowment
This is the most common type of interest-only mortgage. It provides life assurance cover and a fixed payment for investment. The fixed payments are based on the amount of the loan together with the mortgage term and are designed so that, at maturity, the amount invested and the earnings are sufficient to repay the mortgage. It should be noted that there is no guarantee that the sum on maturity will be sufficient to repay the mortgage.
ISA
The Individual Savings Account (ISA) is a tax-free method of saving. Using an ISA as a repayment vehicle is growing in popularity but due to the ISAs complexity it is only for the financially sophisticated or borrowers who seek advice from a suitably qualified financial adviser.
Pension Plan
Life assurance cover is provided and payments are made into a pension fund. When the benefits are eventually taken, the mortgage is repaid using tax-free cash from the balance of the fund. The plan holder can then draw a pension from the remainder of the fund. This product, which tends to be used by the self-employed, is only for those who seek advice from a suitably qualified financial adviser.
Bullet Repayment
The borrower repays interest only during the term of the mortgage. When the mortgage reaches maturity the borrower is required to make a single capital repayment.
Advantages
If the proceeds of the plan exceed the amount required to repay the mortgage, then this is received as a cash lump sum by the borrower.
Some plans are tax-efficient.
Disadvantages
If the proceeds of the repayment vehicle do not achieve the amount expected, then there will be a shortfall. The borrower remains liable for any shortfall on the mortgage hence the outstanding balance will need to be paid off from other resources. Regular checking of the policy fund itself by the borrower and the lender should minimise any risk. If the plan is not reaching its expected target, the borrower can increase payments into the policy or invest in another product to cover any anticipated shortfall.
Cashing in the plans early may result in financial penalties. These will be provided for in the initial agreement. In addition the lender has no way of tracking some of the more modern repayment vehicles, such as an ISA, which will result in some instances where a borrower lets an investment lapse by forgetting or not realising it is to be used to repay the mortgage. This will result in situations where there is no method of repaying the mortgage at the end of the mortgage term.
Some lenders may offer a 'part and part' mortgage where part of the mortgage is repayment only and part of the mortgage is interest only.
Fees
It is common practice for lenders to charge up-front fees in the form of booking fees and/or arrangement fees. There will almost certainly be a charge to have the security valued, and the lender will usually require the funds with the initial application. Legal fees will apply, and borrowers should seek advice from a suitably qualified solicitor or conveyancer.
The majority of lenders will charge a penalty for early settlement of the mortgage. This fee may be charged for up to five years after the mortgage was taken out. This is often known as a lock-in period, and it acts to discourage borrowers from re-mortgaging with another lender at more favourable terms.
You should always protect your repayments to ensure that the outstanding balance of the mortgage is repaid in the event of death, accident, sickness and the inability to work.
HOW DO I APPLY?
Lending institutions offer you the option of applying for your commercial mortgage either in person at the branch, via a written application or online. Assessments are on a case-by-case basis and take into account a borrower's personal circumstances and financial standing.
GET A TAILORED QUOTE & APPLY FOR A COMMERCIAL MORTGAGE WITHOUT LEAVING THIS SITE!
We offer a tailored quote facility and online application service through our commercial mortgage finder. This is service is available by clicking here. You will be asked to complete a questionnaire to provide further details of your requirements and this allows you to confirm whether you require a new mortgage or whether you are re-mortgaging an existing property. You can also confirm the stage you are currently at, e.g. whether an offer has been made and/or accepted, contracts exchanged or whether you are just looking or just want to know what you can afford. The information collected is not an application and no credit checks will be performed until you instruct us to do so.
If you don't like forms you can use the telephone service to discuss your requirements. The number can be found on the tailored quote questionnaire. Please note we do not charge a fee for the service we provide.
This information should be read in conjunction with our terms and conditions. It is recommended that you should always seek independent financial advice before entering into any form of contract.
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YOUR PROPERTY IS AT RISK IF YOU DO NOT KEEP UP THE REPAYMENTS OF A MORTGAGE OR OTHER LOAN SECURED ON IT
