Commercial mortgages: how to buy or refinance business premises

A commercial mortgage is a loan to buy, or refinance, property that's used for business rather than as someone's home. The lender takes a charge over the building, which lets it sell the property if the loan isn't repaid. In return, you get a large sum over a long term, usually at a lower rate than an unsecured business loan.

That sounds like a home mortgage. The differences are in the deposit, how the lender judges what you can afford, and what the process costs.

Owner-occupied or investment: the first question

Lenders put commercial property into two broad groups, and almost everything else follows from which one yours is in.

• Owner-occupied means your own business trades from the building, like a café buying its premises or an engineering firm buying its unit. The lender relies on your business's profits to repay the loan.
• Investment means you let the building to someone else, such as a parade of shops. The lender relies on the rent to repay the loan.

There's a third, in-between type: semi-commercial or mixed-use property, like a shop with a flat above. Some lenders treat it more favourably than purely commercial property. If you or a relative will live in the residential part, tell the lender or broker early. A loan secured on property that's partly your home can fall under FCA mortgage rules, which changes who can lend and how.

How much deposit you'll need

Lenders don't lend the full value of a commercial property. They lend a percentage of it, called the loan-to-value (LTV), and you put in the rest as a deposit.

As a broad guide, many lenders cap commercial mortgages somewhere around 60% to 75% of the property's value, so a deposit of 25% to 40% is common. Where you land in that range depends on:

• The property. A modern unit in a busy area that lots of businesses could use is easier to sell than a specialist building, so it usually supports more borrowing.
• Your trading record. Several years of steady profits help. A young business may be asked for a bigger deposit.

The LTV is worked out on the lender's valuation, not the price you agreed. If the valuer says the building is worth less than you're paying, the loan shrinks and you have to find the difference.

How lenders decide what you can afford

Security reduces the lender's loss if things go wrong, but it doesn't replace the need to show you can pay. The test depends on the property type.

Owner-occupied: your trading profits

The lender asks whether your business's profit covers the new repayments with room to spare. Most start from profit before interest, tax, depreciation and amortisation (EBITDA), a rough measure of the cash your trading generates.

They'll also add back the rent you currently pay, since you'll stop paying it once you own the building. That often makes the numbers work better than people expect. A business paying £30,000 a year in rent may find a mortgage costs a similar amount, with the difference that it's paying off its own asset.

Expect to provide two or three years of accounts, recent management accounts, business bank statements and details of any existing borrowing. Our guide to the documents you need for a business loan covers the full list.

Investment: the rent

For a let property, the lender compares the rent with the mortgage interest. It wants the rent to exceed the interest by a set margin, often called interest cover, so there's a cushion if rates rise or a tenant falls behind.

The quality of that rent matters as much as the amount: how sound the tenants look, how long their leases have left to run, and whether the rent matches the market, which the valuer will check. A tenant who can leave in six months is worth far less to a lender than one signed up for ten years.

A building with no tenants is much harder to finance with a standard commercial mortgage. That's often where a short-term bridging loan comes in, with a mortgage taking over once the units are let.

Terms, rates and repayments

Commercial mortgages commonly run from a few years up to 20 or 25, sometimes longer. A longer term means lower monthly payments but more interest overall.

• Repayment or interest-only. Repayment clears the loan over the term. Interest-only means lower payments but the full loan is still owed at the end; some lenders allow it, especially on investment property.
• Fixed or variable. A fixed rate holds your payments steady for an agreed period. A variable rate usually tracks the Bank of England base rate or another benchmark, plus a margin.
• Early repayment charges. Fixed rates in particular often carry a charge if you repay or switch early. Check this if you might sell or refinance within a few years.

Rates are set case by case: usually higher than on a home mortgage, because commercial property is harder to sell, and lower than unsecured business borrowing.

As with most lending to companies, the lender will usually ask directors for a personal guarantee on top of the charge over the property.

Valuations, legal costs and timescales

This is where commercial mortgages differ most from borrowing that lands in days.

Valuation. The lender instructs a surveyor, usually a member of the Royal Institution of Chartered Surveyors (RICS). You pay for it whether or not the loan goes ahead, and commercial valuations cost more than residential ones.

Legal costs. You'll need your own solicitor for the purchase, and you'll normally pay the lender's legal costs too. The solicitors check the title, the planning position, any leases and any restrictions on how the building can be used.

Other fees. Expect a lender's arrangement fee, often a percentage of the loan, and possibly a broker fee. Ask for every fee in pounds before you commit.

Stamp duty. Buying property usually means paying a land tax: Stamp Duty Land Tax in England and Northern Ireland, Land and Buildings Transaction Tax in Scotland, and Land Transaction Tax in Wales. Non-residential property has its own rates, which differ from residential ones. Check the current figures on GOV.UK or ask your solicitor.

VAT. Some commercial buildings carry VAT on the purchase price, because the seller has chosen to charge it (known as "opting to tax"). In some cases, such as buying a let building as a going concern, VAT may not apply. Stamp duty is generally worked out on the price including any VAT, so this can affect the tax bill too. Ask your solicitor and accountant early, as it changes how much cash you need on the day.

Timescales. From application to completion, two to three months is a reasonable expectation, and complex deals take longer. The valuation and legal work set the pace. If you're buying at auction or against a hard deadline, a mortgage may simply be too slow, and a bridging loan can fill the gap.

A worked example. A joinery business pays £30,000 a year in rent and has the chance to buy its unit for £400,000. A lender values the unit at the asking price and offers 75% loan-to-value: a £300,000 mortgage over 20 years. The business puts in a £100,000 deposit. On top of that, it needs stamp duty, both sides' legal fees, the valuation and the arrangement fee, which together can easily add thousands, and more if VAT applies. The lender checks that the business's profits, with the old rent added back, cover the new repayments with room to spare. This is an illustration, not a quote: your figures will depend on your business and the property.

Buying through a limited company or SPV

You can buy commercial premises personally, through your trading company or through a separate company set up just to own the property. That last option is often called a special purpose vehicle, or SPV.

A common set-up is two companies: a trading company that runs the business, and a property company that owns the building and lets it to the trading company on a proper lease. The aim is to keep the building apart from the risks of trading. If the trading business ever ran into trouble, the property would sit in a separate company.

Lenders are used to all three routes. With a company or SPV, expect to give personal guarantees, and for the lender to look at the trading company's accounts too.

The tax consequences differ a lot between the routes, including on rent, on selling the building later and on passing it on. This is a decision to make with your accountant before you make an offer, because changing who owns a building afterwards can trigger stamp duty and other taxes.

Using a pension to buy premises

Some business owners buy their premises through a pension, usually a SSAS (small self-administered scheme) or a SIPP (self-invested personal pension). Both can hold commercial property, though not, in general, residential property.

In outline:

• The pension buys the building, using its own funds and, if needed, borrowing. A registered pension scheme can generally borrow up to 50% of its net assets.
• Your business then rents the building from the pension, on a formal lease at a market rent.
• The rent goes into your pension rather than to a landlord.

It can work well, but the rules are strict and the tax penalties for breaking them are serious. Not every provider allows property, and money in a pension can't simply be taken back out. Take regulated financial advice and talk to the scheme's administrator before you go any further.

Refinancing premises you already own

A commercial mortgage isn't only for buying. Businesses also use one to switch lender when a fixed rate ends, to release money tied up in a building they own, or to replace more expensive debt with a cheaper, longer loan. The process is much like a purchase, with a new valuation and legal work. Our guide to secured vs unsecured business loans explains how a charge over property compares with other security.

Common mistakes to avoid

• Budgeting for the deposit only. Stamp duty, legal costs, valuation, arrangement fees and any VAT all need cash, usually before or on completion.
• Assuming the valuation will match the price. A lower valuation means a smaller loan. Have a plan for the gap.
• Choosing who owns the building last. Personal, company, SPV or pension ownership each have different tax results, and switching later can be costly.
• Ignoring early repayment charges. If you might sell or move within the fixed period, the exit cost matters as much as the rate.
• Leaving it too late. If you face an auction or a fixed completion date, line up your finance first.

Questions people ask

How much deposit do I need for a commercial mortgage?

Commonly 25% to 40% of the property's value, because many lenders cap lending at around 60% to 75%. The exact figure depends on the property, your trading record and the lender. You'll also need cash for stamp duty, fees and any VAT.

Can a new business get a commercial mortgage?

It's harder, but not impossible. Lenders usually prefer two or three years of accounts. A newer business may need a bigger deposit, a strong business plan or relevant experience in the sector to show it can keep up the repayments.

How long does a commercial mortgage take?

Two to three months from application to completion is a reasonable expectation, and complex deals can take longer. The valuation and legal work usually set the pace. Starting early, with your documents ready, is the best way to avoid delays.

Can I buy commercial property through my pension?

Often, yes, through a SSAS or a SIPP that allows it. The pension owns the building and your business can rent it at a market rate. The rules are strict and mistakes can be costly, so take regulated financial advice first.

Is a commercial mortgage regulated by the FCA?

Commercial mortgages to companies are generally unregulated. A loan secured on property that you or a family member partly live in, such as a flat above a shop, may be regulated. A broker or lender can tell you which applies to your case.