Commercial mortgages: how they work and what lenders need

The lender advances a sum against a building and registers a first legal charge over it at HM Land Registry. You repay over an agreed term, usually monthly. The interest can be fixed for a period or variable, typically priced as a margin over the Bank of England base rate or another reference rate. Unlike a bridging loan, there is no need to prove how the debt will be cleared at the end: the monthly payments do that work, or the balance is refinanced when the term ends.

Before offering, the lender will want to see who owns the property today and what charges, restrictions and rights are recorded against it. You can check this yourself for a small fee by searching the HM Land Registry register, which is worth doing before you commit to valuation fees on a building with an unexpected covenant or an old charge still registered.

• A professional practice or trading company buys the building it currently rents, replacing rent with repayments that build equity. Our guide to buying your business premises goes through that decision in detail.
• An investor or property company buys a building let to business tenants. Here the rent services the debt, which is why commercial investment mortgages have their own underwriting.
• A business that bought quickly with a bridge, perhaps at auction or with works to do, moves onto long-term debt once the building is ready.
• An existing loan is reaching the end of its term, or the owner wants to release equity for expansion. That is covered on our commercial property refinance page.
• A buyer acquires a freehold trading business, such as a pub, hotel or care home, where the property and the business are bought together.

Two separate tests set the ceiling. The first is loan-to-value: owner-occupied premises in good locations are commonly funded at up to around 70 to 75% of value, with lower limits for investment, specialist or secondary buildings, and each lender sets its own maximum. The second is serviceability. For an owner-occupier, the lender compares the business's profit before interest, tax and depreciation with the total annual repayments on all its borrowing, looking for a clear margin rather than a break-even figure. For a let building, it compares the rent with the interest cost, usually tested at a rate above the one you will actually pay.

Illustration (hypothetical round figures): a company wants to buy a unit valued at £800,000. A 75% loan-to-value cap would allow up to £600,000. But after allowing for its existing vehicle finance and a working capital loan, its profits only support repayments on around £500,000. The lender offers £500,000, so the company needs £300,000 of its own money plus purchase costs, not the £200,000 it had assumed. Running both tests before making an offer avoids that surprise.

A commercial mortgage is a relationship that lasts for the term, not a one-off transaction. Lenders commonly require:

• Annual accounts and sometimes management figures, so they can test performance each year.
• Financial covenants, such as a maximum loan-to-value or a minimum level of profit or rent cover. Falling outside one can allow the lender to reprice, ask for a capital repayment or extra security, even if every payment has been made on time.
• Consent before you grant a new lease, change the use of the building or carry out structural works.
• Buildings insurance with the lender's interest noted, and sometimes a revaluation at the lender's request.

Read the facility letter's covenant section carefully with your solicitor. It is often where two offers that look alike on price differ most.

High-street banks tend to price keenly for established, profitable businesses with conventional property, but they can be strict about sector, trading history and building type, and may expect your day-to-day banking. Challenger banks often take a more flexible view of the business case and newer companies. Specialist lenders fund more unusual buildings, shorter trading records and complex ownership structures, generally at higher cost or lower loan-to-value. Private banks sometimes lend against a wider relationship. Because appetite varies so much, the same building can receive very different terms, which is why we compare the market rather than start with one lender.

A commercial mortgage is usually available to established, profitable businesses and experienced investors buying a building that a lender would be comfortable to sell or relet, with a deposit typically of 25% to 40% from their own resources and, ideally, two or more years of accounts. Lenders test that through the following checks.

• The valuation, the building's condition and how easily it would sell or let if the lender had to take possession
• Trading history, profitability and existing borrowing for owner-occupiers, or lease terms and tenant strength for let buildings
• Where the deposit comes from; money borrowed elsewhere to fund the deposit weakens the application
• The directors' or partners' credit history and their wider assets and liabilities, since personal guarantees are common
• Whether VAT is payable on the purchase, which affects how much cash is needed at completion; HMRC explains the rules in its guide to opting to tax land and buildings

The building itself is the main security: the lender registers a first legal charge over it, and for a company borrower it often takes a debenture over the business as well.

Personal guarantees from directors or partners are common, particularly for owner-occupied premises and newer companies; some lenders cap the guarantee at a fixed sum or a percentage of the loan, which is worth negotiating. On a let building the lender will usually take an assignment of the rental income, and on owner-occupied premises it may ask for life or key person cover on the people the business relies on. Where the deposit is thin, a second charge over another property can sometimes make up the shortfall. Our guide to debentures and fixed and floating charges explains each layer.

A commercial mortgage typically takes around 6 to 12 weeks from application to completion, and longer for complex buildings, multiple tenants or new borrowing structures.

Indicative terms often come within a week or two of a full information pack. Most of the remaining time goes on the lender's valuation, its credit approval and the legal work: title checks, searches, reviewing leases and, where relevant, VAT and transfer-of-going-concern questions. Leasehold premises that need the landlord's consent, buildings with planning or environmental issues, and a newly formed SPV that needs its own checks all add time. Having accounts, the debt schedule and proof of deposit ready before an offer is accepted removes the most common early delays.

Beyond interest, expect an arrangement fee, the lender's valuation and legal fees, your own solicitor's costs and, on many products, early repayment charges. Your building is security for the loan, and a personal guarantee can put personal assets at risk if a sale fails to clear the debt. Variable-rate borrowers carry the risk of rate rises across a long term, so test repayments at higher rates before committing. Finally, compare ownership with continuing to rent: a mortgage commits capital and makes relocation slower, which suits a settled business better than one still finding its size.

The main alternatives are to keep renting, to buy the building through a different structure, or to combine a smaller mortgage with other funding.

• Buying through a company pension scheme or SPV, which our guide to SPV and pension ownership compares.
• Mezzanine finance layered behind the mortgage where the deposit falls short, at higher cost.
• Land finance or development finance if you are buying a site or building new premises.
• Staying a tenant and using fit-out finance to improve rented space, which keeps capital in the business.