What is the process for refinancing a commercial mortgage?

Refinancing a commercial mortgage is a significant financial decision for any UK business owner or property investor. Whether you are looking to secure a lower interest rate, consolidate debt, or release capital for expansion, understanding the precise steps involved is crucial for a successful outcome. This process differs substantially from residential refinancing due to the complexity of the commercial property market and the detailed analysis lenders conduct regarding the operating business.

What is the process for refinancing a commercial mortgage? A step-by-step UK guide

Refinancing a commercial mortgage involves replacing an existing loan secured against commercial property (such as offices, warehouses, retail units, or industrial premises) with a new loan, usually provided by a different lender, or renegotiated with the current provider. The process is rigorous and requires careful preparation and expert guidance.

Phase 1: Initial Preparation and Goal Setting

Before approaching any lender, clarity regarding your objectives is essential. Commercial refinancing is driven by specific business needs, and the lender will require a clear justification for the switch.

Determine Your Refinancing Objectives

You must clearly define why you are seeking a new mortgage. Common reasons include:

• Rate Reduction: Moving from a higher variable rate to a lower fixed rate, or securing a better rate upon the expiry of an existing fixed term.
• Capital Raising: Releasing equity from the commercial property to fund business expansion, acquire new assets, or inject working capital.
• Term Adjustments: Altering the repayment structure, such as extending the mortgage term to reduce monthly outgoings.
• Debt Consolidation: Merging multiple commercial debts into a single, potentially more manageable, loan facility.

Conduct a Financial Health Check

Lenders base their decision primarily on two factors: the value and security offered by the commercial property and the financial strength and stability of the borrowing entity (the business). You must prepare documentation showing your ability to service the new debt.

Key documents typically required at this stage include:

• Three years of audited business accounts or financial statements.
• Proof of income and asset statements for all directors/guarantors.
• Details of the existing mortgage and outstanding balance.
• A detailed business plan outlining future projections, especially if capital is being raised for growth.

Review Your Credit Profile

While commercial lending focuses heavily on the business’s performance, the credit history of the directors and guarantors plays a vital role. Any adverse credit history must be disclosed and explained upfront.

It is prudent to review your personal and business credit reports early to identify any potential issues that may delay the application.

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Phase 2: Sourcing and Decision in Principle (DIP)

Once your paperwork is in order, the next step is to find a suitable lender and gain an initial assessment of eligibility.

Engage a Commercial Broker (Recommended)

The commercial mortgage market is vast and fragmented, featuring high-street banks, specialist lenders, and bridging finance providers. A commercial broker specialising in property finance can access a wider range of products and often negotiate better terms than a business can secure directly. They are instrumental in matching your specific business risk profile to lenders willing to underwrite it.

Obtain a Decision in Principle (DIP)

The DIP, sometimes called an Agreement in Principle (AIP), is a preliminary indication from a lender that they are willing to lend, based on the information provided regarding the property and the business’s financial health. This involves an initial, non-binding assessment. If the DIP is granted, the lender will issue a list of requirements needed for the full application.

It is important to remember that a DIP is conditional and does not guarantee the final loan offer; it is purely based on the initial figures submitted.

Phase 3: Formal Application and Underwriting

This is the most intensive phase, where the lender conducts rigorous due diligence to verify all claims and assess the true risk of the loan.

Submit the Full Application Pack

The full application requires comprehensive submission of all necessary financial documents, identification, and details about the property, including lease agreements (if the property is tenanted) and planning permissions.

The Property Valuation

Lenders require a formal, independent valuation of the commercial property by a surveyor approved by them. This valuation determines the Loan-to-Value (LTV) ratio—the size of the loan relative to the property’s worth. The valuation must confirm the property’s suitability as security and assess its marketability should the lender ever need to sell it upon default.

Unlike residential valuations, commercial valuations often consider the specific nature of the business operating from the property and the quality of the lease income, if applicable. The cost of this valuation is typically borne by the applicant, regardless of whether the loan proceeds.

Business Assessment and Financial Ratios

The underwriter will scrutinise your financial accounts to calculate key lending ratios. The most critical is the Debt Service Coverage Ratio (DSCR).

• Debt Service Coverage Ratio (DSCR): This ratio measures the business’s net operating income against the total debt service (principal and interest payments). A typical commercial lender requires a DSCR significantly above 1.0 (e.g., 1.25x or 1.5x) to ensure that the business generates enough income to comfortably cover the new mortgage payments, with a sufficient buffer left over.
• Stress Testing: Lenders often “stress test” your ability to repay by calculating affordability assuming future interest rate increases, ensuring the loan remains sustainable even in adverse economic conditions.

Phase 4: Legal Due Diligence and Formal Offer

If the underwriting team is satisfied with the financial health and the property valuation, the process moves into the legal phase, where the security is formally established.

Legal Instruction and Search

Both you and the lender will instruct solicitors. Your solicitor represents your interests, while the lender’s solicitor undertakes searches and checks to ensure the security offered is legally sound and unencumbered. These searches include:

• Title deeds verification and Land Registry checks.
• Environmental and planning searches.
• Reviewing existing charges or covenants on the property.
• If the property is tenanted, detailed review of all commercial lease agreements to ensure they meet the lender’s requirements.

Reviewing the Formal Offer

Once all legal and financial checks are complete, the lender issues a formal loan offer. This document is legally binding and must be reviewed meticulously by your solicitor. The offer will detail:

• The exact loan amount and repayment schedule.
• The interest rate (fixed, variable, or linked to the Bank of England base rate).
• Any associated fees (arrangement fees, exit fees, legal costs).
• The specific terms and covenants, which are conditions that must be adhered to throughout the life of the loan (e.g., maintaining certain financial ratios or not making material changes to the property without permission).

It is vital to understand the terms associated with the security. If you fail to meet the repayments as agreed, the security is at risk. Your property may be at risk if repayments are not made. Consequences of default can include legal action, the imposition of increased interest rates, additional administrative charges, and, ultimately, repossession of the commercial property.

Phase 5: Completion and Fund Transfer

The final phase involves signing the legal documents and completing the transfer of funds.

Signing the Mortgage Deed

Your solicitor will arrange for all necessary documents, including the new mortgage deed and security agreements, to be signed by the relevant directors or guarantors. You must be fully satisfied with the terms before signing, as this finalises the legal obligation.

Redeeming the Existing Loan

On the completion date, the new lender transfers the agreed funds. These funds are used first to pay off the existing commercial mortgage, including any early repayment charges (ERCs) that may apply. Any remaining funds (if the refinancing was for capital raising) are then transferred to your business bank account.

Registration

Finally, the lender’s solicitor registers the new charge against the commercial property at the Land Registry, replacing the old lender’s charge. This formally concludes the refinancing process.

Common Challenges in Commercial Refinancing

While the steps are clear, practical challenges often arise that can delay or derail a commercial refinancing application:

• Early Repayment Charges (ERCs): Many commercial mortgages include steep penalties for repaying the loan before the end of the contracted term. The potential savings from a new rate must outweigh the cost of these ERCs.
• Valuation Discrepancies: If the independent valuation comes in lower than expected, the LTV ratio increases, potentially leading the lender to reduce the loan offer or withdraw it entirely.
• Complexity of Ownership Structure: Applications involving complex ownership structures (e.g., trusts, holding companies, or multiple interlocking entities) require significantly more due diligence and time.
• Market Shifts: Commercial lending confidence can shift rapidly. If economic conditions change during the application period, lenders may tighten their criteria or increase interest margins, even after a DIP has been issued.

To navigate these complexities and ensure compliance, consulting reliable UK sources on business finance, such as guidance from the government or regulatory bodies, is always advisable. For further information on managing business finance, you can consult resources from organisations like Government guidance on business finance and support.

People also asked

How long does it take to refinance a commercial mortgage?

The process typically takes 6 to 12 weeks from initial application to completion. However, complex cases involving specialist properties, large loan values, or complicated legal structures may extend this timeline significantly, sometimes requiring three to six months.

What fees are involved in commercial refinancing?

Fees usually include an arrangement fee (which can be 1% to 3% of the loan amount), valuation fees (paid upfront), legal fees for both the borrower and the lender’s solicitors, and potentially early repayment charges (ERCs) from the existing mortgage provider.

What is the minimum Loan-to-Value (LTV) ratio required?

Commercial lenders typically require a lower LTV than residential lenders. While maximum LTVs vary by lender and property type, they often range between 60% and 75%. The actual LTV offered depends heavily on the strength of the business and the quality of the security property.

Can I refinance if my business is currently loss-making?

Refinancing is significantly harder if the business is loss-making, as lenders prioritise the Debt Service Coverage Ratio (DSCR). However, if the property is purely investment-based (e.g., tenanted), the lender will focus more on the reliability of the rental income rather than the trading business’s profit/loss account.

Do I need personal guarantees for a commercial refinance?

In almost all cases involving small to medium-sized enterprises (SMEs) or private investors, commercial lenders will require personal guarantees (PGs) from the directors or key shareholders. A PG ensures that if the business fails to repay the loan, the lender can pursue the personal assets of the guarantors.

Commercial refinancing demands detailed planning and accuracy across financial, legal, and property domains. By following this structured, multi-phase process and securing professional guidance, businesses can successfully navigate the UK lending landscape to achieve their financial objectives.