Why are commercial mortgages more expensive?

Commercial mortgages are generally more expensive than residential or buy-to-let mortgages, and this comes down to several key factors related to risk, complexity, and how each deal is assessed.

One of the main reasons is that commercial lending is seen as higher risk. Property values in the commercial sector can be more volatile, and income is often tied to the performance of a business or the reliability of a tenant. If a business fails or a lease isn’t renewed, the property could be left vacant, which poses a greater risk to lenders compared to residential properties, where demand is usually more stable.

Another important factor is the individual assessment process. Commercial mortgage rates aren’t usually off the shelf, they’re based on bespoke underwriting. Lenders look closely at the business’s financial accounts, and things like the loan-to-EBITDA ratio (earnings before interest, tax, depreciation, and amortisation) can heavily influence pricing. A high loan-to-EBITDA ratio signals greater risk and may result in a higher interest rate or even a rejection.

For investment properties, the strength of the tenant known as the covenant strength also plays a major role. A lease with a strong, well-known tenant (like a supermarket or bank) is seen as lower risk and may attract a better rate. On the other hand, a weaker or unknown tenant may lead to higher rates, as lenders are less confident in the reliability of rental income.

Because of these risk factors and the custom nature of each loan, commercial mortgages tend to come with higher interest rates and fees than both residential and buy-to-let mortgages. Each deal is unique, and lenders price according to the risk profile of the property, the borrower, and the income being relied on to service the loan.