There are several important differences between commercial finance and the more mainstream finance that most people are used to.
When an individual contacts their bank or mortgage lender for a loan there is an automated system which evaluates the applicants income, financial commitments and general status. This evaluation is then measured against a set of known predictors which gives the lender an overview of how likely they are to get their money back. This automated process is widely known as “credit scoring” which is different from “credit checking”.
When a business approaches a commercial lender for a commercial loan there is a different set of variables to consider. In the case of a commercial mortgage the commercial lender will obviously need a full background of the business they are lending money to. These background checks will include the people who control the business. Whether you are a director of a limited company or a sole trader you should be prepared to answer questions about your personal circumstances when applying for a commercial loan. Only very strong commercial propositions will avoid the need for personal guarantees.
Drawing parallels between a residential mortgage and a commercial mortgage, you could think about a company’s audited accounts in the same way as an individual’s payslips or P60. A commercial lender will look for evidence that the stated income (profit) is sufficient to cover the loan. A set of audited accounts will give the lender details about the business income, financial commitments and general status. The net profit for a company is then used to evaluate the affordability in the same way that the “take home” pay for an individual is used.
How closely the lender will look at the accounts will depend on the Loan to Value (LTV), the amount of money being borrowed, and general viability of the business. In the current commercial mortgage market there is the option to “self-cert” a business income and thus avoid the need to have accounts examined. But self-cert does of course carry its own ‘price’. Very often the interest rate is higher where supported evidence in the form of audited accounts cannot be provided.
Just like a residential mortgage, a commercial lender will insist on independent verification of the value and condition of the property. This verification is usually carried out by a qualified surveyor who is chosen from a panel of recognised companies. Not all residential surveyors are able to carry out commercial valuations. Depending on the type of business a specialist report may also be required.
So in conclusion, the question most often asked is “Why is a commercial mortgage so much more expensive that a residential one?” Well, in simple terms, the cost of a loan is usually dictated by the perceived risk to the lender, and in reality far more businesses end up in bankruptcy and repossessions than individuals.
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