What is the difference between a commercial mortgage and a business loan?

Understanding your business funding options is crucial for growth and stability. While both commercial mortgages and business loans provide capital, they serve very different purposes. A commercial mortgage is a long-term loan used specifically to buy property or land, secured against that asset. A business loan is more flexible, used for general operational needs, and can be secured or unsecured with a shorter repayment term. The main risk with any secured finance is that your asset could be repossessed if you fail to keep up with repayments.

Choosing the right type of finance can have a significant impact on your company’s financial health. A commercial mortgage is a specialised tool for property acquisition, while a business loan is a versatile solution for a wide range of operational expenses. This guide will break down what each product is, how they work, and help you decide which is the right fit for your business needs.

What is a commercial mortgage?

A commercial mortgage is a long-term loan used by a business to buy property or land for commercial purposes. Much like a residential mortgage you might take out to buy a home, a commercial mortgage is secured against the property you are purchasing. This means the lender has a legal claim over the property until the loan is fully repaid.

Because the loan is secured by a high-value asset, lenders see it as less risky. This often translates to larger loan amounts and longer repayment periods compared to other forms of business finance.

Key features of a commercial mortgage:

• Purpose: Strictly for purchasing business premises (like an office, retail shop, or warehouse), a commercial buy-to-let property, or land for development.
• Security: The loan is secured against the property being bought. It’s vital to understand this commitment. Your property may be at risk if repayments are not made. Failing to meet your obligations could lead to consequences such as legal action, repossession of the property, increased interest rates, and additional charges.
• Loan Amount: Typically higher, often starting from £25,000 with no set maximum, determined by the property’s value and your business’s ability to afford the repayments.
• Loan-to-Value (LTV): Lenders usually offer up to 75% of the property’s value, meaning you’ll need a deposit for the remaining 25%.
• Repayment Term: Long-term, generally ranging from 5 to 25 years.

What is a business loan?

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A business loan provides a lump sum of cash that you repay, with interest, over an agreed period. Unlike a commercial mortgage, its use is far more flexible. You can use the funds for almost any legitimate business purpose, from boosting cash flow to financing a new marketing campaign.

Business loans come in two main forms: secured and unsecured.

• Secured Business Loans: These are borrowed against a business asset, such as equipment, invoices, or another property you own. Because there is collateral, they often have lower interest rates than unsecured options.
• Unsecured Business Loans: These are not tied to a specific asset. The lender makes its decision based on your business’s credit history, turnover, and overall financial performance. Due to the higher risk for the lender, interest rates are typically higher and loan amounts may be smaller.

Key features of a business loan:

• Purpose: Very flexible. Can be used for working capital, buying stock or equipment, hiring new staff, paying a tax bill, or funding growth projects.
• Security: Can be either secured against business assets or unsecured.
• Loan Amount: Varies widely, from as little as £1,000 to several million, depending on the type of loan and the lender’s assessment of your business.
• Repayment Term: Shorter-term, typically from 1 to 5 years.

Key Differences at a Glance

To make the choice clearer, let’s compare commercial mortgages and business loans across several key areas.

Purpose of the Loan

This is the most fundamental difference. A commercial mortgage is for one thing: buying property. A business loan can be used for almost anything else your business needs to operate and grow.

Security and Risk

A commercial mortgage is always secured against the property you’re buying. A business loan might be secured against other assets or completely unsecured. With any secured finance, the risk is the same: if you default on your repayments, the lender can take steps to repossess the asset you used as security.

Loan Term

Commercial mortgages are long-term commitments, reflecting the value and lifespan of a property. Repayment periods of 20 years or more are common. Business loans are designed to solve more immediate needs and are therefore paid back over a much shorter period, usually within 5 years.

Interest Rates

Interest rates are influenced by risk. Because commercial mortgages are secured against valuable, stable property, their rates are often lower than those for business loans, especially unsecured ones. Lenders view an unsecured business loan as a riskier prospect and price the interest rate accordingly.

Application Process

Applying for a commercial mortgage is an intensive process. Lenders will scrutinise your business’s finances, your personal financial standing, and conduct a detailed valuation of the property. The process can take several weeks or even months.

Applying for a business loan, particularly an unsecured one, is often faster. The focus is primarily on your business’s trading history, cash flow, and credit score. Lenders will want to see your accounts and may require a business plan. As part of their checks, lenders will perform a credit search on your business and potentially on you as a director. It’s a good idea to know what they will see. Get your free credit search here. It’s free for 30 days and costs £14.99 per month thereafter if you don’t cancel it. You can cancel at anytime. (Ad)

Can you use a business loan for a property deposit?

Yes, this is a common strategy. If you have a strong business but lack the full 25-30% deposit required for a commercial mortgage, you might use a short-term, unsecured business loan to cover some of the shortfall. However, the mortgage lender will need to be aware of this and will factor the repayments for the business loan into their affordability calculations.

Making the Right Choice

So, what is the difference between a commercial mortgage and a business loan? In short, it comes down to what you need the money for.

• Choose a commercial mortgage if your sole aim is to purchase a property or land for your business to operate from or as an investment.
• Choose a business loan if you need flexible funding for operational costs, growth initiatives, or asset purchases other than property.

Navigating the world of business finance can be complex. Understanding the fundamental differences between these products is the first step toward securing the right funding for your company’s future. For more impartial information on business funding, you can explore the options available on the British Business Bank’s Finance Hub.