Cost effective business borrowing for investment property?
|Borrowing | Loan
Asked by renaissance, submitted
07 October 2009.
Our new business is seeking a £100K loan to partly fund purchasing a holiday rental villa It seems business bank loans have very high interest rates, whilst conventional mortgage rates are much lower. What is the most cost effective way of financing our initial purchase?
Answered by Justin on 08 October 2009
Whether personal or business, mortgage interest rates tend to be lower than shorter-term loan rates.
This is partly because the proportion of borrowers who fail to repay the sum borrowed and/or interest tends to be higher on shorter-term loans than mortgages, so lenders charge a higher rate of interest to compensate for their added risk. Some loans, usually those below £25,000 are also 'unsecured' - again more risky for the lender hence higher interest rates. Also lenders like long term loans because they're usually more profitable, encouraging them to offer more attractive rates of interest to attract borrowers.
Using a mortgage to finance the purchase is therefore likely to be the cheaper option (as you've already discovered), especially if you can repay it over a shorter term.
Your business might be able to get a commercial mortgage, although the interest rate you're offered will be very dependent on your proposition and how risky the lender considers it to be - rates are not standardised like personal residential mortgages. In general, commercial mortgage rates tend to be less competitive than residential mortgages and getting one might prove difficult if the property is overseas. Nonetheless, it would be worth getting a quote from a lender as a comparison.
While the cheapest route is likely to be a residential mortgage, you'll need to take this out personally. If your business is run as a limited company you'll face two issues. Firstly, the business can't practically buy/own the investment property if you've got a personal mortgage on it. Secondly, how to get the mortgage money into the business?
If feasible, you could borrow the money by taking out a residential mortgage on a property you already personally own then lend the money to the company via a director's loan. The company can then use this money to purchase the investment property. If there's other directors you should obviously structure the terms of your loan (i.e. interest etc.) with their agreement. Bear in mind that any interest payments the company makes to you are subject to personal income tax, they must be paid net of basic rate tax and be included in your personal tax return - not ideal. You could perhaps increase your shareholding instead of a loan, but this has other implications.
If you opt for a residential mortgage I'd suggest speaking to your accountant to find the most tax efficient and practical solution for you. Also, don't forget all the usual considerations when choosing a residential mortgage.
Read more about residential mortgages here.
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