What are arrangement fees in a commercial mortgage, and how are they calculated?

Arrangement fees, often referred to as product fees or completion fees, are standard mandatory charges applied by lenders to cover the administrative, legal, and underwriting costs associated with setting up a commercial mortgage. Understanding how these fees are calculated—typically as a percentage of the total loan amount—is crucial for commercial borrowers in the UK, as they significantly impact the overall borrowing cost and the property investment’s viability.

What Are Arrangement Fees in a Commercial Mortgage, and How Are They Calculated?

For UK businesses seeking to finance commercial property—whether it is an office building, a retail unit, or an industrial warehouse—a commercial mortgage is often the primary funding route. While the interest rate garners the most attention, the secondary costs, particularly the arrangement fee, can drastically alter the financial viability of the deal.

An arrangement fee, sometimes called a facility fee or completion fee, is essentially the lender’s charge for processing, setting up, and finalising the mortgage agreement. It is compensation for the administrative workload, the professional time spent underwriting the risk, and ensuring all legal documentation is correctly filed. This fee is non-refundable once the mortgage is completed, even if the loan is repaid early.

Why Commercial Mortgage Lenders Charge Arrangement Fees

Unlike simple residential mortgages, commercial mortgages often involve complex structures, varying risk profiles, and bespoke agreements tailored to the specific business and property. The arrangement fee serves several distinct purposes for the lender:

• Covering Operational Costs: It pays for the extensive administrative and processing work involved in setting up a large commercial facility.
• Underwriting and Due Diligence: Assessing the viability of the commercial enterprise, the stability of the rental income (if applicable), and the value of the property requires substantial professional resource, including analysts and underwriters.
• Risk Pricing: Higher-risk loans (such as those with higher Loan-to-Value ratios or involving non-standard properties) often attract a higher arrangement fee to compensate the lender for the increased probability of default or loss.
• Broker Commission/Distribution Costs: Although separate from a broker fee, the arrangement fee may sometimes indirectly cover costs associated with the distribution channel used by the lender.

It is crucial to request a detailed breakdown of all associated costs early in the application process. Transparency regarding fees is mandated under UK financial regulations, ensuring borrowers understand the true cost of credit before committing.

The Standard Methods for Calculating Arrangement Fees

When assessing what are arrangement fees in a commercial mortgage, the calculation method is almost universally derived in one of two ways, although hybrid models do exist.

Percentage of the Loan Amount (The Standard Method)

The vast majority of commercial mortgage providers calculate the arrangement fee as a fixed percentage of the total amount borrowed. This method ensures that the fee scales proportionally with the size and complexity of the risk undertaken by the lender.

• Typical Range: Arrangement fees in the UK generally range from 0.5% to 5% of the loan principal.
• Impact of Risk: Prime commercial loans secured against high-value, easily marketable property, often with a low LTV (e.g., below 50%), typically attract fees at the lower end (0.5% to 1.5%). Conversely, specialist commercial finance, development finance, or loans with higher LTVs (e.g., 70% or more) may see fees reaching 2% to 5%.

Example Calculation: If a business secures a commercial mortgage of £800,000, and the lender charges an arrangement fee of 2%, the fee payable would be £16,000 (2% of £800,000).

Fixed Fee Structure

Less common in large commercial mortgages but sometimes used for smaller loans or specific standardised products, a fixed fee involves a flat monetary charge regardless of the final loan size (within certain bands).

• Predictability: A fixed fee offers immediate clarity on the cost, aiding budget planning.
• Application: This structure is often employed by specialist lenders dealing with specific niches or standardised portfolios where the underwriting cost remains relatively constant irrespective of minor variations in the loan amount.

However, even with a fixed fee, the lender’s internal calculation is still based on an assessment of the projected costs of administering the loan and pricing the inherent risk.

Understanding the Role of the Applicant’s Financial Profile

The calculation of the fee is not purely mechanical; it is also highly influenced by the lender’s perception of the borrower’s ability to repay. Lenders assess both the commercial viability of the property and the financial standing of the applicant business and its directors.

Part of this assessment involves checking the financial history and creditworthiness of the principals involved. Understanding your current financial position is a critical first step in securing favourable terms.

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Factors That Influence the Arrangement Fee Percentage

While 0.5% to 5% is the typical bracket, specific deal characteristics dictate where on that spectrum the final fee will sit. Commercial lenders look at several key metrics:

1. Loan-to-Value (LTV) Ratio

The LTV is the percentage of the property value the lender is willing to finance. A low LTV (e.g., borrowing 50% of the property value) means the lender has a significant equity cushion, making the loan less risky. Lower risk almost always translates to lower arrangement fees and potentially lower interest rates.

2. Complexity and Non-Standard Properties

If the property is unique, hard to value, or if the loan structure is highly tailored (e.g., involving multiple legal entities or complex security arrangements), the administrative burden and the risk increase. Lenders will charge a higher arrangement fee to compensate for the additional time required by their underwriting and legal teams.

3. Lender Type and Market Position

High-street banks generally offer the most competitive headline rates and potentially lower arrangement fees for straightforward, high-quality commercial assets. Specialist lenders or challenger banks, who may offer more flexible criteria or quicker turnaround times, often charge higher fees (sometimes exceeding 3%) to cover their higher operational costs or niche market risk exposure.

4. Loan Term and Size

Shorter-term loans, while reducing overall interest paid, sometimes carry relatively higher arrangement fees because the lender must recoup its setup costs over a smaller repayment window. Very large loans (multi-million pound facilities) may benefit from slightly lower percentage fees due to economies of scale, though this is not guaranteed.

When and How Arrangement Fees are Paid

The timing and method of payment are crucial considerations that impact the total cost of the mortgage. There are generally three main ways arrangement fees are handled:

1. Upfront Payment (Deducted from Funds)

The borrower pays the fee either upon application (a non-refundable commitment fee) or, more commonly, at the point of completion. If paid at completion, the lender typically deducts the fee directly from the gross loan amount before releasing the funds to the borrower’s solicitor.

Benefit: The borrower avoids paying interest on the fee itself, thereby lowering the total cost of credit over the mortgage term.

2. Rolling Up the Fee into the Loan

Many commercial borrowers choose to add (or ‘roll up’) the arrangement fee to the outstanding principal balance. This means the loan amount increases by the amount of the fee.

Consequence: While this conserves business cash flow upfront, the borrower will then pay interest on the full, increased principal amount (original loan + arrangement fee) for the duration of the term. This significantly increases the total cost of borrowing.

For example, if you roll up a £16,000 fee into a 15-year loan at 6% interest, the cumulative interest paid on that rolled-up fee alone could exceed £10,000.

3. Staged Payments

For complex facilities, particularly development finance or very large bespoke commercial loans, the arrangement fee may be split into stages (e.g., a portion paid upon signing the facility agreement and the balance paid upon completion or specific drawdown milestones).

Negotiating Arrangement Fees in a Commercial Mortgage

While arrangement fees are mandatory, they are often negotiable, particularly in the competitive UK commercial finance market. Effective negotiation requires preparation and strong leverage.

1. Demonstrate a Strong Application

The greater the perceived quality of the borrower, the more inclined the lender will be to reduce the fee. Leverage points include:

• Low LTV ratios (e.g., providing a deposit of 40% or more).
• A robust business plan demonstrating strong, verifiable profitability.
• A clean credit history and positive track record of managing debt.
• High-quality, easily disposable commercial property security.

2. Leverage Multiple Offers

If you have received indicative offers from two or more credible lenders, use the competitor’s quote to negotiate down the fee on your preferred offer. Lenders are often willing to shave 0.25% or 0.5% off the fee to win the business, provided the interest rate remains acceptable.

3. Trade the Fee for the Rate

Lenders have flexibility in how they structure their profit. It is common to trade a slightly higher arrangement fee for a lower interest rate, or vice versa. The optimal strategy depends entirely on the expected term of the loan:

• If you plan to repay the loan quickly (e.g., within 5 years), a lower arrangement fee is usually more important, even if the interest rate is slightly higher.
• If you plan to hold the commercial property for a long period (10+ years), focusing on the lowest possible interest rate, even if it means accepting a slightly higher upfront fee, generally leads to greater savings over the full term.

Comparing Arrangement Fees and Other Costs

Arrangement fees are just one component of the total cost of securing commercial finance. To perform a compliant and thorough comparison, borrowers must account for all related expenses:

• Valuation Fee: Paid to an independent surveyor to assess the property’s worth, required before the lender issues a formal offer.
• Legal Fees (Lender and Borrower): Covering the costs of the solicitor required to draw up the charge and facility agreements. The borrower is typically required to cover the lender’s legal costs as well.
• Broker Fees: If using a commercial mortgage broker, they will charge a separate fee, usually a percentage of the loan amount, for sourcing and packaging the deal.
• Exit Fees: Some specialist mortgages include a fee payable upon final repayment of the loan (usually calculated as a percentage of the original loan amount).

When comparing deals, always focus on the Annual Percentage Rate of Charge (APRC), or the equivalent ‘true cost’ calculation for commercial finance, which incorporates all mandatory fees alongside the interest rate to give a holistic view of the expense.

Compliance and Transparency in UK Commercial Mortgages

In the UK, the commercial lending market is regulated, particularly when lending to smaller businesses or individual investors. Lenders must adhere to strict guidelines regarding transparency.

The Financial Conduct Authority (FCA) expects that all charges, including what are arrangement fees in a commercial mortgage, are clearly detailed and explained to the borrower before they commit to the agreement. Key documents, such as the initial illustration or binding offer, must list the arrangement fee, its method of calculation, and when it is due.

If you feel a lender or broker has not been transparent about their fees, the MoneyHelper service offers impartial advice and guidance on financial products and complaint procedures, which can be useful when dealing with regulated financial providers.

People also asked

Can I get a commercial mortgage with no arrangement fee?

It is extremely rare to find a commercial mortgage with absolutely zero arrangement fees, as lenders must cover their administrative and underwriting costs. If a lender advertises “no arrangement fee,” it typically means the costs have been factored into a significantly higher interest rate, increasing the overall cost of the loan substantially over its term.

Is the arrangement fee refundable if the deal falls through?

Generally, arrangement fees are not refundable if the borrower decides not to proceed or if the application fails due to issues originating from the borrower’s side (e.g., failure to meet legal conditions). However, some initial processing fees, or “commitment fees,” may be refundable if the lender withdraws the offer due to internal reasons, though this varies significantly by lender and must be checked in the terms and conditions.

Are arrangement fees subject to VAT?

For standard commercial mortgage arrangement fees paid to the lender, VAT is typically not applicable because the fee is considered part of the cost of the credit facility, which is usually exempt from VAT under UK law. However, third-party fees, such as broker fees, valuation fees, and legal fees (for the solicitor’s service), are generally subject to standard VAT rates.

What is the difference between an arrangement fee and an exit fee?

The arrangement fee is an upfront cost charged at the start or completion of the loan facility to cover setup and administration. An exit fee (or early repayment charge, ERC) is a fee charged at the end of the loan, usually when the borrower repays the mortgage early or upon scheduled maturity, depending on the terms. Arrangement fees relate to the cost of creation, while exit fees relate to the cost of closure or early termination.

Does rolling up the arrangement fee affect Loan-to-Value (LTV)?

Yes, rolling up the arrangement fee increases the principal debt amount. This higher debt figure is then used in the LTV calculation. If the LTV was already close to the lender’s maximum threshold (e.g., 75%), rolling up the fee could potentially push the loan outside of the acceptable LTV limits, requiring the borrower to fund the fee separately.

Final Considerations on Arrangement Fees

When entering into a commercial mortgage agreement, it is paramount that borrowers treat the arrangement fee with the same scrutiny they apply to the interest rate. By understanding precisely how what are arrangement fees in a commercial mortgage are calculated, based on risk, complexity, and lender type, borrowers can make informed decisions.

Always aim for complete transparency. Request a comprehensive breakdown of all costs associated with the mortgage, including when fees must be paid and whether there are penalties for rolling the fees into the loan. Careful calculation and, where possible, negotiation of this initial charge will help ensure the commercial property investment starts on the strongest possible financial footing.