Commercial Mortgages Complete Guide 2017-05-26T10:52:47+00:00

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The Complete Guide to Commercial Mortgages

Last Updated 10 May 2017.
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Introduction

Commercial mortgages are becoming more popular with both business owners who are looking to buy new premises and property investors. Due to buy to let rule changes, more property investors are moving into commercial and semi-commercial property. The commercial mortgage market is unique. It differs from the residential and buy to let market in various ways. Product information and lender criteria don’t tend to be as freely available and many lenders price their products on a case by case basis.

The difficulty in finding clear information can be off-putting with potential clients unable to find the information they need online. Both lenders and brokers can be guilty of pushing best case scenarios in their advertising with little explanation. Offers of ‘rates from 1.75%’ don’t help with the situation. The reality is that most people will never achieve a rate of 1.75% and we want to give you a more realistic figure to work from.

In this guide, I will give you all the information you need around commercial mortgages. The aim is to give you the full picture and answer any questions you have, without the need to talk to an advisor. We will cover the following:-

  • What is a commercial mortgage?
  • How long do they take to complete?
  • What are the major pitfalls?
  • What are REALISTIC commercial mortgage rates for my circumstances?
  • How much would I be able to borrow?

In addition to these key points, we will cover the other major pitfalls to avoid when taking out commercial mortgages.

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What Is A Commercial Mortgage?

A commercial mortgage is a mortgage loan secured on a commercial property, such as an office, warehouse or shop. A semi-commercial mortgage covers a property such as a shop with a flat above. They are used to secure property for either occupation by the owners business or to be held as an investment.

Commercial mortgages can be used to borrow against a wide variety of property types, including commercial buildings, land and even residential property.

Raising a commercial mortgage against typically residential property is the exception rather than the rule. This will usually happen in one of 2 situations. Firstly, the property is used for part residential and part commercial reasons, such as a large house that is partly used as a B&B. Secondly, a large block of apartments would be difficult to finance using a traditional buy to let due to the number of units. In this situation a commercial view would need to be taken and as such a commercial mortgage would be more appropriate.

Of course, there are a number of combinations of circumstances that could lead to different products being available. If you’re unsure which product is right for your situation, speak to an experienced advisor who will be able to talk it through with you.

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How Does The Process Work?

  1. Talk through your needs with an expert (either lender or reputable broker) who will talk through the project to assess the application.
  2. Assuming the application is viable, you will then receive a quote in writing detailing the interest rate, fees and headline borrowing terms, along with what documents are required to submit a full application.
  3. The documents will be completed and submitted to the lender (if submitted through us, they will be submitted alongside a comprehensive report on the project).
  4. If the lender is happy with the application so far they may want to meet you. At this point, ABC Finance would arrange the meeting for you at a time and place convenient to you.
  5. Once comfortable, the lending manager will usually take your application to the credit committee. These are the underwriters who sign off the application as acceptable to the lender. Once approved, the lender will issue the formal offer, subject to valuation and legal work.
  6. Your formal offer will be issued.
  7. A surveyor is instructed to compile a valuation report on the property. It will be comprehensive and may take longer than a residential valuation to complete.
  8. Your solicitor is instructed to carry out the legal work and satisfy all conditions. They will run through the terms of the agreement and ensure you fully understand the loan. Once satisfied, you will sign the formal offer and return it to the lender. It is important that your solicitor is experienced in dealing with commercial mortgages as inexperience here can slow the process down significantly.
  9. Once all of this is done, the funds can be released and the loan completed.

When taking out a commercial mortgage for the first time, many people use their experience of taking out a residential mortgage as a reference point. This approach does work as there are a number of similarities and just a few differences.

A commercial mortgage tends to take slightly longer its residential equivalent. Residential mortgages tend to be heavily automated, with very little manual underwriting. Commercial mortgages are the opposite in this regard, with applications manually processed and agreed. Although this slows the process down, it does have a major advantage.

Every business can run is a very different way. Their finances and ways of doing things can be completely different. This can be true even of 2 competitors who appear on the outside to be almost identical.

Due to these dramatic differences, commercial mortgage underwriters have to be flexible and look at each application with an open mind. Setting hard and fast rules can prove counterproductive for commercial mortgage lenders. A good example is the assessment of a company’s financial performance. The accounts may show a small profit, however, this may be clouded by significant reinvestment in the business. The future profitability may potentially grow rapidly, however, a set of accounts alone will not show this.

Painting the whole picture to a lender is crucial to getting the best possible deal and ensuring your case completes quickly.

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What Are Realistic Commercial Mortgage Rates?

Rates can vary depending on a number of different factors. The main considerations in pricing an application are the following:-

  • Loan size.
  • The type of lender (and their pricing structures).
  • The desired loan amount.
  • Your credit history.
  • The financials/strength of the business.
  • The length and quality of the tenant and lease (for investment properties).

If your business is established and affordability comfortable, you will generally see a lower interest rate. If you’re planning on using the property as premises for your own business, the interest rate is likely to be lower than if you intend to let the property.

Owner occupied commercial mortgage rates can vary from around 2.25% and go all the way up to 18%. Most loans come in between 2.75% and 7%. Generally speaking, the higher the risk, the higher the interest rate charged.

Commercial investment mortgages come in at slightly higher rates. Particularly strong applications can come in at a rate of 3% or lower. The vast majority of loans will cost between 3.5% and 7%.

Investment properties tend to represent a slightly higher risk to commercial mortgage lenders, which is reflected in the slight increase in rate.

Most loans come in between 2.75% and 7%. Generally speaking, the higher the risk, the higher the interest rate charged.

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Interest Rate Types

Commercial mortgage rates can be either fixed or variable. Fixed rate loans are available for anything from 2 years right up to the length of the loan. Fixed rate commercial mortgages tend to cost slightly more than variable rates. Many lenders price each fixed rate loan individually, meaning an instant quote is not always possible. Some lenders, such as Shawbrook Bank and Interbay Commercial have set fixed rate, although they tend to be the exception rather than the rule.

Variable rates generally track to one of 2 major rates, the Bank of England Base Rate and LIBOR.

The Bank of England Base Rate is the most commonly used interest rate in the UK. It is reviewed monthly and is controlled by the Monetary Policy Committee. LIBOR – The London inter-bank offered rate is a global benchmark rate and is often used in commercial lending in the UK. Neither rate is particularly volatile. In general, you will not see a huge difference between borrowing that is attached to either rate as the lender will price the loan at a suitable margin to suit their perceived risk.

On top of the interest paid, commercial mortgage lenders will generally charge a fee for borrowing the money from them. This is usually paid on completion and is often added to the loan, although some lenders choose to take a small proportion on offer. The fee charged by most lenders tends to be between 1.5% -2%, although on occasion the fee may be either higher or lower.

During the application, you will generally be required to pay for a valuation and legal fees, as with a residential mortgage. Valuation fees on commercial property tend to be higher than those on a residential property and fees are often quoted on a case by case basis. The time taken to complete the report is also slightly longer due to the specialist nature of commercial valuation reports.

Often, lenders will require separate legal representation, which is paid for by you, the borrower. You will, of course, have your own legal fees to pay. Due to the complexity of commercial property titles, these are usually higher than on residential property.

It is recommended that you work with a solicitor who is experienced in commercial property transactions. The process can be quite complex and inexperience in this area can lead to an increase in costs as unexpected delays occur.

The maximum term offered can again vary between industries with certain industries restricted. In general, commercial mortgage lenders will accept a maximum term of 20 years, with some going as high as 25 years. This term is shorter than most residential mortgages. As a result, your monthly repayments are likely to be slightly higher than a residential mortgage of similar size.

For capital repayment mortgages, the shorter the term of borrowing, the less interest is paid per pound borrowed. The interest saved can be significant, so shorter loans can be beneficial, as long as the repayments are affordable.

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Lender Meetings

Some (but not all) lenders arrange a meeting before taking your loan to formal offer. There are three main aims of the meeting:-

  • To get to know you personally.
  • To understand your business personally.
  • To allow the person handling the application to understand exactly what you’re trying to achieve.

Some clients can be nervous before the meeting, but it is an invaluable opportunity to allow the lender to see the positives in your business. It is the time to sell yourself and allow them to see the great difference you could make going forward. The meetings don’t tend to be too scary and in reality, some people who work in banks can actually be friendly!

If you are prepared and know your business, you will find the meeting far less daunting than first feared.

Some lenders arrange a meeting before taking your loan to formal offer. There are three main aims of the meeting:

  1. To get to know you personally.
  2. To understand your business personally.
  3. To allow the person handling the application to understand exactly what you’re trying to achieve.

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What Loan To Value Will I Be Able To Achieve?

The maximum loan on a commercial mortgage application is generally limited due to the loan to value. This works in much the same way as a residential mortgage. Depending on the client’s circumstances, the quality and location of the security property and the intended use of the property, maximum borrowing can vary.

Different lenders will allow a different maximum loan to value. Certain lenders will restrict the maximum loan to value in certain sectors. For instance, a GP practice is allowed to borrow up to 100% LTV with certain lenders, whilst the pub industry is likely to be allowed a maximum of 70%.

When looking to take out an owner-occupied commercial mortgage, most industries are able to borrow up to a maximum of 80% LTV. Interest rates can still be very low up to this level, with 80% commercial mortgages at under 3.5% not uncommon.

For commercial investment properties, the absolute limit is likely to 75%. It’s worth noting that interest rates will tend to increase the closer you get to this figure. The lowest interest rates tend to be available up to 55-60% LTV for commercial investment.

When working out the value, there is a distinction to be made, as different lenders work to different figures. Here are the main valuations that a lender can work to:-

  • Open Market Value (OMV) – The open market value is the price a property should sell for in the open market between a willing buyer and seller. This method calculates the figure on the assumption that there is no compulsion or desire to pay more or less than the true worth of the property when vacant.
  • Going Concern Value (for owner-occupied applications) – This method takes into account the value of the ongoing business in the property and assigns a value to it. E.g. A public house with a good name locally and a regular stream of customers has more value to a potential buyer than a pub which has sat vacant for many years. This value is very real to a buyer but a lender may not be willing to lend against it as it is intangible and could be eroded quickly if mismanaged.
  • Investment Value (for commercial investment applications) – This method assigns a value to the strength of the lease and tenant in the property. It allows for the future income expected from the lease and generates a premium over the open market vacant possession value.
  • 90 Day Value (the 90 day forced sale value) – This is the value that the property would be expected to sell for in a forced sale situation. It allows for the discount applied for a quick sale and will come in lower than the above methods.

These methods of valuation can throw up significantly different figures, meaning the loan to value method generate different maximum loans. It is important to understand what method is used for the commercial mortgage you are looking at before paying for the valuation. A difference in valuation method could create a significant difference in the amount of deposit needed to complete the transaction.

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Do Commercial Mortgage Lenders Accept Adverse Credit?

Yes, there are lenders in the market who will accept an application from you even if you have suffered adverse credit in the past. As the level of adverse credit suffered increases, however, fewer lenders are likely to accept your application. This will generally reduce the maximum loan available to you and will see the interest rate rise.

Lenders will tend to consider missed payments on property-backed debt, such as a mortgage or secured loan as worse than other issues. Missed payments on things such as a mobile phone contract or missed electricity bill. As with other types of finance, lenders will take into account your credit history as a factor that either increases or decreases the likelihood of default. This will then be used to calculate, with a higher risk almost always resulting in a higher interest rate.

It is common to see 100% commercial mortgages advertised online and we receive a lot of questions about how these work. To achieve 100% funding, you will need additional security to balance the risk to the lender. The additional security would come by way of a second (or more) property offered to bring the average LTV down to the kind of levels shown above.

If you are thinking about using additional security to fund a purchase without putting down a deposit, but all of your properties are mortgaged, the new lender would take 2nd charge behind the main lender. This means the new loan will partly be a second mortgage on the additional properties offered. Although this is available, it is not common and will restrict the number of lenders available. This could result in increased pricing or less favourable terms.

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Capital Raising Through Refinance

When looking to refinance a property that you already own, it is possible to raise additional funds. The most common reasons for doing so are:-

  • Invest back into the business.
  • Further property investment.
  • Refurbish the property.
  • Pay an urgent bill.

Commercial mortgage lenders will generally allow some element of capital raising on your application. Any additional borrowing would have to meet all the other criteria to be acceptable.

Different lenders have different approaches to capital raising, especially when it is for further property investment. Some lenders will release the capital, allowing you to find a property as you see fit, while others will want to know exactly what you’re buying. If you’re looking to raise capital for investment into the business or property, it is important that you’re clear on whether you have definite plans in place. If the lender wants proof of exactly what you’re planning on spending the money on and you’re yet to find the property then your application will be severely delayed.

Checking on what the money is used for is known as ‘following the money’ and is a tool used as a defence against money laundering. As it is used for such an important reason, we recommend being clear on exactly what the money will be spent on before application. There are lenders that will release the funds you need without having a definite plan in place but they reserve the right to delay the application while you find the right property.

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Can I Take Out A Commercial Mortgage On Interest Only?

Yes, commercial mortgages are available on interest only, or full capital repayment. The number of lenders offering interest mortgages is limited, however. This means that by excluding any repayment mortgages from consideration, you may have to pay a higher rate.

Interest only commercial mortgages tend to be restricted to a maximum of 75% loan to value (dependent on sector). Although you will pay a lower interest rate, the overall interest payments over the term of the loan tend to work out higher than on capital and interest.

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I’m Buying A Commercial Property Under Value, Will I Need A Deposit?

Commercial mortgage lenders tend to work on the lower of the purchase price or open market value (OMV). If you’re buying for less than the OMV, you will generally have to put down a deposit based on the purchase price.

The exception to this rule is where you are an existing tenant. If you are an existing tenant and your landlord is willing to sell you the property under value, some lenders will class the discount as a deposit. This is rare and could result in slightly higher commercial mortgage rates, depending on circumstances.

If you are purchasing under value and do not currently occupy the property, the situation is different. You will either have to fund the deposit as shown above or look to take out a bridging loan.

It is more common for a bridging loan lender to consider the difference between purchase price and valuation as a deposit. The downside to this is that bridging loans cost money and will need to be refinanced onto a commercial mortgage when possible. Once the property is owned by you, the lender will generally be more open to working off the OMV, even if purchased under value. This cannot be guaranteed and care should be taken.

Before taking out a bridging loan to secure a commercial property under value, you should consider whether your exit is realistic. If the commercial mortgages available to you would cover the amount of the bridging loan, how much would they cost and how quickly could they complete.

Only if you’re able to afford the bridging loan should completion be delayed and if you’re confident of your ability to repay should you take this route.

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The Factors That Affect Max Loan On An Owner Occupied Application

On top of the loan to value, the lender will look at your ability to repay the debt. When assessing owner-occupied commercial mortgages, your accounts will provide the answers they need to assess the maximum level of debt.

Earnings before interest, tax, depreciation and amortisation.

Different lenders have different calculations and as a result, what is considered affordable by one lender may not be by another. Commercial mortgage lenders will usually work from the adjusted net profit, also known as the EBITDA. EBITDA is the Earnings before interest, tax, depreciation and amortisation

The EBITDA is calculated by simply adding the interest, tax, depreciation and amortisation back onto the net profit. Once this has been done, each lender will then expect this figure to be at least a certain percentage above your annual mortgage repayments at either the interest rate you will pay or a ‘stressed interest rate’. This percentage is usually between 125%-250% and the stressed interest rate (if used) is usually between 3%-6% more than you the rate charged.

This is a slightly simplified version as a good commercial mortgage broker will be able to run through other one-off expenses with you to increase the adjusted net profit. Where you have invested in the business or paid out one-off costs, this will affect your net profit and thus your maximum loan. By explaining each expense and adding it back on top of your EBITDA, your maximum available loan will increase.

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Will Commercial Mortgage Lenders Accept Projections?

If your business is expecting growth in the next 12 months, projections will be accepted by some lenders. The key to using projected income is to ensure the figures are realistic and can be backed up by a logical case for their attainment.

If you’re expecting growth this year then it is important to be clear why that is and how it can be measured. For instance, if this year is already up on last year, that will help. If there has been an investment into the business with increased demand expected, that is also a positive.

Projections are difficult to predict and it’s important that the lender is given reasons to trust them. Where there are doubts about certain elements of the projected income, questions will often be raised over the validity of the whole set of projections.

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Would I Be Able To Prove My Income With An Accountant’s Certificate?

Again, there are lenders that will accept this, however commercial mortgages raised purely against an accountants reference will tend to have a higher interest rate. The qualifications of the accountant behind the reference will also be crucial, with most lenders only working from the reference of a chartered or certified accountant.

As you can see, calculating affordability on commercial mortgages can be complex and with lenders tending to have dramatically different calculations, it can be confusing and time-consuming.

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The Factors That Affect Max Loan On A Commercial Investment Property

Commercial investment mortgages work to different criteria than those for owner-occupied properties. On top of the money coming in and the relative ability to pay the debt using this money, the lender will look at the quality of the lease.

Rental income is clearly very important and will play a big role in calculating how much money you’re able to borrow but it is only the first step. The lender will look at the amount of rent received in relation to the anticipated monthly repayment. Rent received will have to be a certain percentage of the monthly payment (usually between 125%-160% – but all lenders are different).

If the loan fits according to this, the lender will then look at the length of the lease. Some commercial mortgage lenders will accept short leases or even no lease. Others will want to see the lease run for the entire length of the loan, restricting the mortgage length as a result. If the maximum term reduces, this will likely reduce the amount you are able to borrow.

Commercial investment – factors that affect borrowing:

  1. Loan to value.
  2. Risk.
  3. Quality of property.
  4. Credit history of applicant.
  5. Reason for the loan.

Commercial leases will often have break clauses inserted into them. A break clause is a provision in a lease that allows the agreement to be ended early. It can be in favour of the tenant, the landlord, or even both.

Even a strong lease with a long term left will be considered risky by a lender if the break clause is in favour of the tenant. This is because the tenant could end the lease at this point without recourse. Where there is a break clause in favour (or partly in favour) of the tenant, the lender will generally treat the date of the break clause as the date the lease expires. This could reduce the maximum loan available and even increase the interest rate charged.

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Not All Tenants Were Created Equal

The quality of the tenant is then considered, specifically their ability to pay the rent. If the tenant is seen by the lender as a risk, this could cause an issue. Depending on the perceived level of risk, the lender will take appropriate action.

If there is only one tenant and they are considered to be at a high risk of failure to pay the rent for the term of the lease, then this could restrict or even prevent lending. Generally speaking, this is fairly uncommon and there will usually be a redeeming feature, such as high demand for re-letting that could counterbalance the risk.

Where there are a number of tenants, the risk of total loss of rent is reduced. This means your loan application is less likely to run into issues as a result of tenant quality. If you’re concerned this could apply to your application, discuss this point upfront with your lender or broker. A good broker will generally be able to place your application with a suitable lender, who will accept the tenant profile of the property.

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Will I Have To Switch My Banking Facilities To The New Lender?

Different lenders take different views in this area. Some lenders will insist that you switch all banking to them as a condition of the loan. In cases such of these, the loan will be dependent on the switch. Sometimes we will be able to negotiate this position to ensure you only have to have certain payments going through the account or even remove the requirement altogether.

On other occasions, the lender will be comfortable to issue the loan without any switch of banking. There is no hard and fast rule. Switching banking can be complicated and time consuming for some businesses.

If the idea of switching banking is something you are keen to avoid, then you should make the lender or broker aware straight away. A commercial mortgage broker will usually still be able to offer you a mortgage without the need for banking to be switched. It may be worth looking at the best loan with banking switched and the best without. That way you are able to make an informed decision about what is best for you as an overall package.

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Could Other Factors Affect My Application?

Some lenders will see experience as a huge factor while others will be more comfortable with little to no experience. Commercial mortgage lenders tend to take an overall view of the application, looking at the overall likelihood of there being an inability to repay the debt in the future.

On all cases, a lender will be concerned about your background commitments and will consider your assets, liabilities, income and expenditure. This gives them an overall picture of your finances. A strong asset or income base behind you will help you when other factors may count against you, such as a lack of experience.

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I’ve Been Turned Down By My Own Bank. Will I Still Be Able To Get A Commercial Mortgage?

Commercial mortgage lenders have very different requirements when assessing a loan. Even if you’ve been turned down by your own bank, a good commercial mortgage broker may be able to help.

There are lots of specialist lenders who can be a lot more flexible than high street banks. When looking for a new lender, assessing the whole market can actually result in a much better fit for your business. Different lenders tend to favour different sectors and different circumstances. Because of this, an application that was turned down by one lender may be seen as an ideal case by another.

When looking for a new lender after a case has been declined, the commercial mortgage rates offered won’t always increase. Perception of risk and pricing is very different at different lenders and as such you may find you’re still able to enjoy competitive rates, regardless of previous adverse credit or declined applications.

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The Benefits Of Using A Broker

When looking at commercial mortgages, people are often torn whether they would be best to approach lenders directly, or work with a reputable broker. Firstly, a reputable broker will offer you truly impartial advice. This means you will be able to secure the best possible deal and will have confidence in the advice you receive. An independent broker will have ties to a single lender’s products.

A broker will manage the process from start to finish, fully preparing your application before submission and fighting your corner when decisions are being made. This positive influence on negotiations can see you experiencing far less stress and could even save you money by preventing issues before they arrive.

Finding the right lender can be time-consuming in such a complex market and as such a broker can save you a lot of time. This effect will be compounded when they manage large chunks of the process on your behalf once the right lender is found.

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What Are Regulated Commercial Mortgages?

Commercial mortgages become regulated if 40% or more of the property is to be used as or in connection with a dwelling.
This occurs where a property is used to both live in and trade from. The property must be occupied residentially by the person taking out the mortgage and would still be classed as regulated even if the commercial part was let.

Commercial mortgages become regulated if 40% or more of the property is to be used as or in connection with a dwelling.

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Conclusion

Commercial mortgages work on a case by case basis and every lender takes a different approach to assessing an application. There are certain factors that will always bring comfort to a lender and some that will worry them. The key to a successful application is presenting the information clearly and in the right way is very important.

The decision between using a reputable commercial mortgage broker or going directly to the lender is an important one. It may be worth having a conversation with a broker initially to get some unbiased advice. This will give you a good idea of the likely rates you would be able to achieve based on your circumstances.

Remember to be upfront about what you’re looking for. If you don’t want to switch your banking, or you’re unwilling to offer a personal guarantee, then say it upfront. If you don’t you’re more likely to end up with it dropped on you later on, when there is less time to lose.

Commercial mortgages don’t have to be as complex as they first seem. It’s important to understand the way each application is assessed and what your lender is likely to accept. From there presenting the facts and getting your application accepted will become more straightforward and save a lot of time.

For more information on commercial mortgages, head over to our commercial mortgages product page. Alternatively, enquire online or speak to an advisor on 01922 620008.

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Fixed & Variable
market leading rates

Adverse Credit
can be accepted

Interest Only
as well as repayment

No Maximum Loan
100% LTV available