A commercial mortgage is the most common way to finance the purchase of land or buildings for a business. It is often the most flexible and affordable solution. How Does a Commercial Mortgage Work?
Commercial mortgages may be structured several different ways but the two most important aspects to consider are the interest rate type and the repayment schedule. There are basically two interest rate options for you to consider... Fixed Interest Rate: the interest rate applied remains constant for a set period that may or may not equal the length of your mortgage. The advantage of a fixed rate loan is that your interest rate and mortgage repayments are fixed and will not rise if the market rate rises. The disadvantage is that you will not benefit from any reduction if interest rates fall.
Variable Interest Rate: the interest rate applied fluctuates in line with changes to the Bank Base Rate or LIBOR rate and, as a result, so will the amount of your payments. Generally, you can initially get a lower interest rate on variable interest rate than on a fixed rate mortgage. The advantage of a variable rate mortgage is that you save money when the market rate decreases. The disadvantage is that the interest rate you pay can increase with the market rate.
When deciding on your repayment schedule you should remember the longer you take to payback the original mortgage loan the higher your total interest payment will be. Advantages of a Commercial Mortgage
You retain ownership. Instead of raising funds by selling an interest in the property or the business, you retain complete ownership of both. The lender is only entitled to an interest return on its mortgage, not a percentage of ownership that an investor would expect. Also the lender can only exercise the right if you default. You retain all the benefits of ownership in an asset that has the potential to appreciate in value.
Improved cash flow. A commercial mortgage gives you access to capital with minimal up-front payments and the flexibility to design a repayment schedule that suits your needs.
Maximise financial leverage. Financing your property purchase with a mortgage will allow you to use your cash flow for other pressing needs.
Simplified cash flow management. Mortgage schedules are preset, making cash management more predictable.
Tax advantage. Interest payments on your mortgage are tax deductible and are made with pre-tax money. Purchases financed with profits, in contrast, are, made with after-tax money.Disadvantages of a Commercial Mortgage
Mortgage collateral. The nature of a mortgage requires you to pledge the purchased property to the lender. If you default on the mortgage, the lender is able to foreclose upon the property and sell it to repay the money owed to the lender.
Defaults. The lender may define a variety of events that will constitute a default on the mortgage, including failure to make any payment on time, bankruptcy, insolvency and breaches of any obligations in the mortgage documents. Try to negotiate advance written notice of any alleged default, with a reasonable amount of time to settle the default.Things to Watch out for
Arrangement fees. A commercial mortgage lender may charge up-front arrangement or processing fees. Check these fees carefully, and try to get an estimate as soon as possible to help you evaluate the overall mortgage cost.
Redemption penalties. You want to be free to pay off the mortgage (all or in part) at any time before its due date. Unfortunately a lot of lenders are likely to charge a redemption penalty in the first 3 to 5 years of the mortgage. After that initial period, you should make sure that your mortgage agreement gives you this flexibility and try to avoid a prepayment penalty for paying off the mortgage or part of the mortgage early.
Grace period. Try to get a grace period for any payments. For example, the monthly payments may come due on the first day of each month, but they won't be deemed late until the fifth day of the month.
Sale and leaseback. An alternative to mortgaging a property is to enter a sale and leaseback. In this transaction, you would sell the property to a buyer, who would immediately lease the property back to you. In this situation the main advantage is that the buyer would be required to find the financing for the purchase. However you have sold your ownership of the property and you would not benefit from any appreciation in its value.
Legal and professional Fees. Before you complete your purchase and ownership of the property passes to you, you will incur additional costs and fees for arranging the mortgage. Ensure that these are clear and reasonable before signing on the dotted line.
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