How Commercial Mortgage Works for a Business?
A commercial mortgage is a type of business loan, which is secured against a property that is not owned by the borrower at that time. This type of funding is usually opted by businesses that are looking to expand or invest in a new property. However, there are a lot of things to consider before you go for this type of business financing. For instance, you should be aware that there is no set interest rate for a commercial mortgage, which means that the lending institution can impose any desired charges based on the risk level. Besides, the rates would also depend upon the loan period and repayment terms.
Usually, a commercial mortgage can be availed for a 3-year term to a 25-year period. The lengthier the repayment term, the lesser the rates would be. Still, it would be determined based on the risk factors, which is assessed by the lending party after due analysis of the borrower’s financial history. Sometimes, this type of loan can also have a variable rate agreement, which means that the repayment amounts can fluctuate every month. The variable rate is decided based on the scope and potential of the business as well as the property value.
Applying for a Commercial Mortgage
A commercial mortgage is usually chosen by businesses when they need some additional funding to buy a new property for business expansion or to save on their monthly rental overheads. This can also be a good option for those who already have a property – they can release the value of the building to use the funds for other business ventures.
You can apply for a commercial mortgage even if you have a bad credit score. All you need to apply is the previous years’ profit/loss statements, rent roll, tax returns, photos of the property, and personal financial statement. You can also produce summaries of capital improvements to get the loan approved quickly. However, as the risk would be more here due to your poor credit score, the interest rates could be very higher.
Note that the lending institution would also perform a standard valuation of the property before approving the commercial mortgage. Moreover, there can be additional costs too, such as arrangement and legal fees. Therefore, it is better to clarify every detail carefully before applying for the funding.
Types of Commercial Mortgages
Generally, commercial mortgages are categorized into three types: owner-occupied, residential buy-to-let, and commercial buy-to-let. The first type is meant for businesses that are either looking to buy the building or space where they are currently operating or want to buy a new property to shift their business operations there. Residential buy-to-let funding is meant for those businesses that want to acquire a residential property loan to free up their business operations.
Commercial buy-to-let is similar to the residential buy-to-let type of mortgage; the only difference here is the type of property the business is looking to buy. For instance, this type of funding can opt when a company wants to buy a commercial warehouse to let it out to other businesses. This is the most difficult type of commercial mortgage to acquire though.
Pros and Cons of a Commercial Mortgage
The most striking benefit of choosing a commercial mortgage is that you would not have to pay any monthly rentals anymore. This can be a great thing when you are looking to explore new markets and planning to grow your business reach. You can customize the space as you want and change the layout to suit your business operations as applicable too. Besides, if the repayments are higher than what you can bear, you can always sub-let a free portion of the property to another party for a monthly lease. However, you would need to get permissions from your lender for that.
The interest on the repayment amount for a commercial mortgage is tax-deductible, so that would reduce some financial burden from your shoulders. What’s more, as the value of the real estate grows, the capital of your business would also go higher. Yet the main drawback of this type of small business funding is that you might need to pay a considerable deposit upfront to buy the property. This is usually around 20% of the commercial mortgage amount. In addition, if the commercial mortgage rate is variable, then you cannot determine the exact interest amount to be paid per month, and it can go up any time.
Another downside of buying a property is that you can no longer move to another location in case your business demands it at some point. On top of that, you would be responsible for the maintenance of the building and fixing any problems like HVAC repair or broken windows. Note that if the real estate value drops at any time, the capital of your business will also decline with it. So it is better to weigh all options before making the decision.