Understanding a Commercial Mortgage

In many ways a commercial mortgage is just like a residential mortgage in that you pledge real property as collateral against a loan to either buy or refinance that property. You can also receive a commercial re-mortgage and use it as a line of credit for any business purpose.

When you use a commercial mortgage to buy property, or to raise funds for any other business purpose, the lender retains an interest in that property until the loan has been paid in full. Unlike other types of business loans, which usually have a relatively short repayment period, you can take out a loan for as long as 30 years if you like.

The lender receives repayment of the commercial mortgage principal and interest over the lifetime of the loan. If you default on the loan and go into arrears then the lender can foreclose and take possession of the property that was used as collateral.

Generally speaking, the interest on a commercial mortgage is tax deductible and the net proceeds of the loan are not considered to be taxable income. However, you should always check with your accountant to be sure because the tax consequences can be severe should it be determined that your usage of the funds was not for a qualified business purpose.

Should you be seeking a commercial mortgage for the purposes of operating your business, rather than actually buying property, then the lender will either want to re-finance your current mortgage, and include enough money to provide the amount that you are seeking, or they may arrange an equity line where they lend you the difference between the current value of your commercial property and the amount that you owe on the current mortgage.

There are generally two types of interest schemes available when you are applying for a commercial mortgage. 

The fixed rate commercial mortgage establishes an interest rate that is in place either for the life of the loan or for a fixed period of time. If it is for a fixed period of time then it will normally convert over to the second type of rate, which is called a variable interest rate, after the fixed time period expires.

In some cases your lender may add a Early Redemption Charge (ERC) clause to your commercial mortgage contract which states that if you pay off the note prior to the end of the fixed rate period then the lender is entitled to a one-time lump fee to offset their loss of expected income. In some cases this ERC may extend to longer periods possibly up to the entire term of the loan. Be very sure to read your loan contract carefully to make sure that you understand the implications of the ERC if it is present.

With competition from lenders heating up you'll find that many of them are dropping ERC clauses all together. If there is one present in your loan contract you may be able to negotiate it away with little effort. It's worth trying in any case and you can always apply somewhere else if your lender is not willing to negotiate.

In the case of a variable interest rate commercial mortgage the rate is based upon those issued by Bank of England. The lender will usually state that the rate consists of the published rate, which will likely vary up and down over the life of the loan, plus some pre-determined premium that remains the same for the life of the loan. Be sure that you understand how frequently your rate will change and that you are comfortable with the amount that the lender is charging as a premium. As with any terms of your loan you can negotiate both of these factors.

A fixed rate commercial mortgage is a good choice when you feel that interest rates are headed up sharply and you want to lock in the current rates. On the other hand, if interest rates are in flux, and economic indicators point to a downtrend, then a variable rate may be your best choice.

Keep this strategy in mind during the lifetime of your commercial mortgage. If you are locked into a fixed rate, and interest rates have dropped significantly below what you are paying, you should consider applying for a re-mortgage and selecting a variable interest rate to take advantage of the lower rates. On the other hand, if you are in a variable, and all indicators are that interest rates will be skyrocketing soon, then look to move into a fixed rate so you can protect yourself against future increases.