Understanding Commercial Mortgage Interest Rates: What Drives Changes

If you're in the market for a commercial property or planning to refinance an existing loan, you've likely come across the topic of interest rates.

But what exactly influences these rates? Why do they seem to shift so unpredictably?

Understanding the factors behind commercial mortgage interest rates can help you make more informed decisions, whether you're securing financing for a retail shop, office space, or industrial site. 

The Basics of Commercial Mortgage Interest Rates

First off, what are we actually talking about?

A commercial mortgage interest rate is the cost a lender charges for borrowing money to fund a commercial property purchase. It's typically expressed as a percentage and can be fixed (stays the same throughout the loan term) or variable (fluctuates based on broader market conditions). The type you choose can depend on your business needs, risk tolerance, and market trends.

But here’s the key thing: these rates aren’t picked out of thin air. They’re shaped by a mix of economic factors, the lender's risk assessment, and even details about the property itself.

What Economic Factors Are at Play?

Let’s get one thing clear – the wider economy has a massive influence on commercial mortgage rates. You don’t need to be an economist to understand the basics, though. Here’s how it works:

1. Central Bank Rates - The Big Lever

The interest rates set by central banks, such as the Bank of England, are a critical starting point. When central banks raise their base rate, borrowing costs for lenders go up. Naturally, these higher costs trickle down to borrowers like you. On the flip side, when central banks lower rates, it often leads to cheaper commercial mortgages.

2. Inflation – The Silent Driver

Inflation impacts everyone, including lenders. If inflation rises, lenders demand higher interest rates to ensure their returns keep pace with the decreasing value of money. For example, if inflation is at 5%, a 3% interest rate on your loan would effectively result in a loss for the lender.

3. Economic Stability – Confidence Matters

Economic booms and downturns can shift interest rates dramatically. During periods of growth, rates often climb as demand for loans increases. In contrast, during recessions, lenders may reduce rates to stimulate borrowing, although they might tighten lending criteria to mitigate risks.

How Do Lenders Assess Risk?

Lenders aren’t just looking at the economy when setting commercial mortgage interest rates – they’re also looking at you. Well, more specifically, your business, property, and financial situation.

Here are a few ways they assess risk:

1. Creditworthiness – Your Financial Track Record

If your business has a strong credit history and consistent revenue, you're likely to secure a lower rate. A poor credit score, missed payments, or unpredictable cash flow can make lenders view you as a riskier bet, leading to higher rates.

2. Loan-to-Value Ratio (LTV) – How Much Are You Borrowing?

The LTV ratio compares the loan amount to the property’s value. A lower LTV – say 60% – signals less risk to the lender, which can translate to lower interest rates. If you're borrowing closer to 80% or 90%, expect the rates to rise as the lender's risk increases.

3. Property Type and Location – Specifics Matter

Not all commercial properties are created equal in a lender’s eyes. A well-located office in a thriving business hub may command better rates than a retail space in a declining area. The type of property (office, industrial, retail, or mixed-use) also plays a role in determining how risky the investment appears.

Fixed vs Variable Rates: Which Should You Choose?

Now that you know what drives interest rates, let’s talk about how they’re applied to your loan. Fixed and variable rates each have their pros and cons, depending on what you prioritise:

Fixed Rates – Stability at a Price

A fixed-rate mortgage offers predictable payments throughout your loan term. This can be a good option if you prefer certainty and want to avoid fluctuations. However, you might pay slightly more for this peace of mind, as fixed rates are often higher than initial variable rates.

Variable Rates – Flexibility with Risk

Variable rates rise and fall in line with a benchmark (like the central bank rate). While these loans can start off cheaper, they come with the risk of increases over time. If rates spike, your payments could become more expensive than you’d planned for.

Think about your business goals, cash flow, and appetite for risk before deciding.

How Can You Secure a Better Rate?

Understanding the factors is only half the battle – the other half is knowing how to leverage them to your advantage.

Here are some practical tips:

1. Boost Your Creditworthiness

Pay off existing debts where possible and make sure your credit history is spotless before applying. Lenders will scrutinise this closely.

2. Aim for a Lower LTV

If you can afford a larger deposit, it could significantly reduce your interest rate. A smaller loan amount relative to the property value makes lenders more comfortable.

3. Shop Around

Different lenders have different criteria, so don’t settle for the first offer. Work with a mortgage broker who can help you find competitive rates tailored to your needs.

4. Consider Timing

Interest rates can fluctuate based on market conditions. If possible, lock in a rate during a period of economic stability or when central bank rates are low.

Why Staying Informed Matters

Understanding commercial mortgage interest rates isn’t just about saving money – it’s about empowering your business.

The more you know about what drives these rates, the better positioned you are to negotiate favourable terms and make smart financial decisions.