Interest-Only Commercial Mortgages Explained
An **interest-only commercial mortgage** requires you to pay only the interest on the loan each month, without repaying any of the capital balance. The full loan amount remains outstanding throughout the mortgage term and must be repaid in a lump sum at the end.
This structure is extremely common in commercial property finance. Unlike residential mortgages, where interest-only has become increasingly restricted, commercial lenders routinely offer interest-only terms for sound commercial and financial reasons.
At **Commercial Mortgages Broker**, we advise clients across the UK on whether interest-only or repayment structures best suit their commercial property finance requirements.
How Interest-Only Works
The mechanics of interest-only lending are straightforward:
Monthly Payment Comparison
| Loan Amount | Rate | Interest-Only Monthly | Repayment Monthly (25yr) | Difference |
|---|---|---|---|---|
| £500,000 | 5.0% | £2,083 | £2,922 | £839/month |
| £1,000,000 | 5.0% | £4,167 | £5,845 | £1,678/month |
| £2,000,000 | 5.0% | £8,333 | £11,690 | £3,357/month |
The cash flow advantage is clear. On a £1 million loan, interest-only payments are £1,678 per month less than capital repayment, freeing up over £20,000 per year in cash flow.
What Happens at the End of the Term
When the mortgage term expires, you must repay the full loan amount. This is called the **exit strategy**, and it is the most critical element of any interest-only commercial mortgage application.
Advantages of Interest-Only
Maximised Cash Flow
Lower monthly payments mean more cash available for:
- Business operations: Owner-occupiers retain more working capital
- Property maintenance: Funds for ongoing repairs and improvements
- Portfolio building: Surplus cash can be used as deposits for additional properties
- Tax efficiency: Interest payments are fully deductible against rental income for tax purposes
Higher Borrowing Capacity
Because monthly payments are lower, the **debt service coverage ratio** (DSCR) is easier to satisfy, potentially allowing you to borrow more than you could on a repayment basis.
Flexibility
Interest-only provides maximum flexibility to deploy capital elsewhere. If your investment generates higher returns than the mortgage interest rate, it makes financial sense to keep capital working rather than repaying cheap debt.
Tax Efficiency
For commercial property investors, mortgage interest is deductible against rental income for tax purposes. On an interest-only mortgage, the full monthly payment is deductible. On a repayment mortgage, only the interest portion is deductible (not the capital repayment element).
**Key Takeaway:** Interest-only commercial mortgages maximise tax efficiency because 100% of each monthly payment is an allowable expense against rental income.
Disadvantages of Interest-Only
No Equity Build-Up
Unlike a repayment mortgage, your loan balance never decreases. If property values fall, you could end up in negative equity with no mechanism to reduce the debt through normal payments.
Exit Strategy Risk
You must have a credible plan to repay the full loan at the end of the term. If property values have fallen, refinancing options have reduced or your sale plans have not materialised, you could face serious difficulties.
Higher Total Interest Cost
Because the balance never reduces, you pay interest on the full amount for the entire term:
| Loan: £1m at 5% | Interest-Only (25yr) | Repayment (25yr) |
|---|---|---|
| Total interest paid | £1,250,000 | £753,360 |
| Difference | - | £496,640 less |
Over 25 years, the interest-only borrower pays almost £500,000 more in total interest. This is the cost of maintaining cash flow flexibility.
Lender Review Risk
Many commercial mortgages have periodic reviews (typically every 5 years). At review, the lender reassesses the property value, income and your financial position. If circumstances have deteriorated, the lender could require you to switch to repayment or reduce the loan balance.
Exit Strategy Requirements
Every interest-only commercial mortgage application requires a credible **exit strategy**. Lenders need to be satisfied that you can repay the full loan balance at the end of the term.
Accepted Exit Strategies
**Sale of the property**: The most straightforward exit. The property is sold and the mortgage is repaid from the proceeds. Lenders will consider current and projected property values relative to the loan.
**Refinance**: Taking out a new mortgage to replace the existing one. This is common but lenders increasingly question whether refinance alone is a sustainable long-term exit, particularly for older borrowers.
**Sale of other assets**: If you have other properties, investments or business assets that could be sold to repay the mortgage.
**Business sale**: For owner-occupied properties, the sale of the business (including the property) upon retirement.
**Pension funds**: Drawdown from pension savings to repay the mortgage balance.
**Partial repayment**: Some borrowers make voluntary capital repayments during the interest-only term, reducing the amount to be repaid at exit.
Exit Strategy Assessment
Lenders evaluate exit strategies by considering:
- Realistic property value at term end: Will the property be worth enough to repay the loan?
- Borrower age: Will the borrower be able to refinance at the end of the term, or will age restrict options?
- Market conditions: How sensitive is the exit strategy to market downturns?
- Concentration risk: Is the exit dependent on a single event or asset?
**Key Takeaway:** "I will refinance" is no longer sufficient as a standalone exit strategy for most lenders. You need to demonstrate realistic, detailed plans for repaying the capital.
Lender Criteria for Interest-Only
Lenders that offer interest-only [commercial mortgages](/services/commercial-mortgages) typically require:
Debt Service Coverage Ratio
The property's net rental income must cover the mortgage payments by a comfortable margin:
- Minimum DSCR: 1.25x to 1.5x (the property generates 125-150% of the mortgage payment)
- Stress-tested DSCR: Many lenders stress-test at a higher rate (e.g., current rate + 2%) to ensure the property can service the debt if rates rise
Loan-to-Value Ratio
Interest-only LTV limits are typically the same as for repayment commercial mortgages:
- Standard: Up to 65-75% LTV
- Premium: Up to 80% LTV for exceptional cases
- Typical first-time buyer: 60-70% LTV
Lease Requirements
For investment properties, lenders examine the lease:
- Unexpired lease term: Should extend well beyond the mortgage term
- Tenant covenant: Financial strength of the tenant
- Rent review provisions: Upward-only rent reviews preferred
- Break clauses: May reduce the lender's assessment of income security
Borrower Requirements
- Net worth: Sufficient personal assets beyond the property
- Income: Alternative income sources that could cover payments if the property is vacant
- Experience: Track record in commercial property (more important for interest-only than repayment, as the risk is higher)
- Age: Some lenders restrict maximum borrower age at the end of the term
Part-and-Part Mortgages
A **part-and-part** structure combines elements of both interest-only and repayment:
- A portion of the loan is on an interest-only basis
- The remaining portion is on a capital repayment basis
For example, on a £1 million loan at 70% LTV, a lender might structure:
- £600,000 on interest-only (up to 60% LTV)
- £400,000 on repayment
This approach reduces the exit strategy risk (the repayment portion reduces automatically) while still providing better cash flow than a fully amortising mortgage.
Interest-Only vs Repayment: Which Is Right?
Choose Interest-Only When:
- Cash flow is a priority (you need to maximise available funds)
- You have a clear, credible exit strategy
- You can deploy the cash flow savings to generate returns exceeding the mortgage rate
- Tax efficiency is important (100% deductible payments)
- You plan to sell the property within the mortgage term
Choose Repayment When:
- You want to build equity and reduce debt over time
- You plan to hold the property long-term and want it mortgage-free eventually
- You are approaching retirement and want to eliminate property debt
- You do not have a clear exit strategy for the capital balance
- You prefer the certainty of a reducing debt
Consider Part-and-Part When:
- You want some capital reduction but cannot afford full repayment payments
- The lender is uncomfortable with full interest-only but the property cannot support full repayment
- You want to reduce the exit strategy burden gradually
Which Lenders Offer Interest-Only?
Most commercial mortgage lenders offer interest-only terms, including:
- High-street banks: Lloyds, NatWest, Barclays and HSBC all provide interest-only commercial mortgages for suitable applications
- Challenger banks: Aldermore, Shawbrook, Allica Bank, Paragon and Hampshire Trust frequently offer competitive interest-only terms
- Specialist lenders: Investec, Recognise and others cater to specific sectors or higher-value transactions
The key differentiator between lenders is not whether they offer interest-only, but how they assess exit strategies and what stress-testing they apply.
How CMB Can Help
Our team advises on the optimal structure for your commercial mortgage, taking into account your current cash flow needs, long-term objectives and exit planning. We access the full market to find the most competitive interest-only terms available.
[Contact us](/contact) to discuss whether interest-only is the right structure for your commercial property finance.
Frequently Asked Questions
Below are the most common questions we receive about interest-only commercial mortgages.
*Written by Matt Lenzie, Founder of Commercial Mortgages Broker. Ex-Lloyds Bank & Bank of Scotland.*