How It Works
Commercial Mortgages may be structured
several different ways but the two most important aspects
to consider are the interest rate (type and method)
and the repayment schedule for the loan.
There are two interest rate options for you to consider:
- Fixed Rate: With a fixed rate the
interest rate (i.e. the percentage) applied to the
outstanding principal remains constant through out
a predetermined period that may or may not equal the
length of your mortgage. The interest rate is set
at the beginning of your mortgage by examining the
risk involved and the current market rates. Obviously
the main advantage of this is that the rate will stay
the same and not be determined by other factors, but
the disadvantage would be that you would not benefit
from a decline or drop of the market rate.
- Variable Interest Rate: With a
variable interest rate the interest rate applied on
the outstanding principal fluctuates from in line
with changes to the Bank Base Rate or LIBOR and, as
a result, so will the amount of your payments. The
interest rate for each period will be the current
market rate plus a predetermined premium that remains
constant throughout the life of your mortgage. Generally,
you can initially get a lower interest rate on variable
interest rate than on a fixed rate mortgage. Of course
the main advantage would be that you would save money
if the market is in your favour, but equally, you
are not protected if the market does change and you
may end up paying more.
When deciding on your repayment schedule you should
always remember the longer you take to payback the principal
the higher your total interest payment will become:
- "Equal" Payments: Probably
the most common schedule, this type of mortgage requires
you to pay the same amount each period (monthly or
quarterly) for a specified number of periods. Part
of each payment covers the interest and the rest reduces
the principal.
- "Equal" Payment and a Final Balloon
Payment: This type of mortgage requires you
to make equal monthly payments of principal and interest
for a relatively short period of time. After you make
the last instalment payment, you must pay the balance
in one payment, called a balloon payment. Some lenders
will give you the option to refinance the mortgage
to help you stretch out the final balloon payment.
This type of mortgage offers definite benefits to
you. Because of the lower monthly payments during
the course of the mortgage, you can keep more cash
available for other needs. Of course, when you are
thinking about those nice low payments, don't forget
the big balloon payment waiting around the corner.
- Interest-Only Payments and a Final Balloon
Payment: With this type of mortgage, your
regular payments cover only interest. The principal
stays the same. At the end of the mortgage term, you
must make a balloon payment to cover the entire principal
and any remaining interest. The obvious advantage
of this arrangement is the low periodic payments.
But over the long term, you will pay more interest
because you are not reducing the principal sum on
which you pay interest.
- Endowment Mortgage: This type of
mortgage is similar to an interest-only mortgage but
the repayment of the principal comes from the proceeds
of an endowment. Several types of endowments are eligible
for this type of mortgage, they include: life assurance
policy, personal or executive pension plan policy,
or a personal equity plan. The additional security
provided by the endowment usually result in a lower
interest rate.
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Commercial
Mortgages Guide
