Interest-Only Commercial Mortgages: How They Work, Rates & Criteria
Interest-only is the most common repayment structure for commercial mortgages in the UK. Unlike residential lending -- where interest-only has been heavily restricted since the Mortgage Market Review -- commercial lenders routinely offer interest-only terms because the economics of commercial property investment naturally suit this structure.
As an ex-banker who structured hundreds of commercial property loans at Lloyds Bank and Bank of Scotland, I can confirm that the majority of commercial mortgage applications we saw were on an interest-only basis. There are good reasons for that, but also genuine risks that borrowers need to understand before committing.
What Is an Interest-Only Commercial Mortgage?
With an interest-only commercial mortgage, your monthly payments cover only the interest charged on the loan. You do not repay any of the capital balance during the mortgage term. The full loan amount remains outstanding and must be repaid in a lump sum when the mortgage matures.
For example, on a 1,000,000 loan at 5.5% interest:
- Interest-only monthly payment: 4,583
- Capital repayment monthly payment (25-year term): 6,141
- Monthly saving on interest-only: 1,558
- Annual cash flow advantage: 18,696
That is a significant amount of cash retained in the business or investment each year. Over a five-year fixed rate term, the interest-only borrower retains over 93,000 more than the repayment borrower.
The trade-off is clear: at the end of the mortgage term, you still owe the full 1,000,000. On the repayment mortgage, your balance has reduced to approximately 855,000 after five years.
Interest-Only vs Capital Repayment: Detailed Comparison
The choice between interest-only and repayment is one of the most important decisions in structuring your commercial mortgage. Here is how they compare across key metrics.
Monthly Payment Comparison
| Loan Amount | Rate | Interest-Only | Repayment (25yr) | Monthly Saving |
|---|---|---|---|---|
| 500,000 | 5.25% | 2,188 | 2,996 | 808 |
| 1,000,000 | 5.50% | 4,583 | 6,141 | 1,558 |
| 2,000,000 | 5.75% | 9,583 | 12,560 | 2,977 |
| 5,000,000 | 5.00% | 20,833 | 29,224 | 8,391 |
Total Interest Cost Over 25 Years
The long-term cost difference is substantial:
| Loan: 1m at 5.5% | Interest-Only | Repayment (25yr) |
|---|---|---|
| Total interest paid | 1,375,000 | 842,300 |
| Capital repaid through payments | 0 | 1,000,000 |
| Balance at end of term | 1,000,000 | 0 |
Over 25 years, the interest-only borrower pays approximately 530,000 more in total interest. However, this comparison does not account for what the borrower does with the cash flow savings. If those savings are invested productively -- earning returns above the mortgage rate -- interest-only can actually produce a better overall financial outcome.
Impact on Debt Service Coverage Ratio
The DSCR calculation is directly affected by your repayment structure:
- Property net income: 75,000 per annum
- Interest-only annual payments: 55,000 -- DSCR = 1.36x
- Repayment annual payments: 73,692 -- DSCR = 1.02x
With interest-only, this property comfortably passes most lenders' minimum DSCR requirement of 1.25x. On a repayment basis, it barely covers the payments and would likely be declined.
This is precisely why interest-only is so prevalent in commercial lending. Many commercial properties that are perfectly viable investments would fail the DSCR test on a capital repayment basis.
Pros of Interest-Only Commercial Mortgages
Maximised Cash Flow
The most obvious advantage. Lower monthly payments mean more cash available for business operations, property maintenance, portfolio expansion, or building reserves. For property investors managing multiple assets, the cumulative cash flow benefit across a portfolio can be transformational.
Higher Borrowing Capacity
Because interest-only payments are lower, the DSCR is easier to satisfy. This can mean the difference between securing finance at your target LTV and having to inject more equity. In practical terms, a borrower who can only borrow 600,000 on a repayment basis might secure 750,000 or more on interest-only terms.
Tax Efficiency
For commercial property investors, mortgage interest is fully deductible against rental income for tax purposes. On an interest-only mortgage, 100% of every monthly payment is an allowable tax deduction. On a repayment mortgage, only the interest element is deductible -- the capital repayment portion is not. This makes interest-only the most tax-efficient payment structure for commercial property.
Importantly, commercial property investors do not face the Section 24 restrictions that have limited interest tax relief for residential buy-to-let landlords. Commercial mortgage interest remains fully deductible at the borrower's marginal tax rate.
Capital Deployment Flexibility
Rather than paying down a 5.5% commercial mortgage, you might deploy the cash flow savings into:
- Additional property deposits generating leveraged returns of 10-15%+
- Business expansion delivering returns far above the cost of debt
- Liquid reserves providing security against void periods or unexpected costs
If your returns exceed the mortgage rate, retaining capital through interest-only makes sound financial sense.
Portfolio Scaling
For investors building a commercial property portfolio, interest-only is often essential. The cash flow savings compound across multiple properties, providing the deposits and working capital needed to acquire additional assets. A portfolio of five properties on interest-only might free up 75,000-100,000 per year compared to repayment -- enough for another deposit.
Cons and Risks of Interest-Only
No Equity Build-Up Through Payments
Your loan balance never decreases through regular payments. If property values fall, you could end up owing more than the property is worth, with no automatic mechanism reducing the debt. During the 2008-2012 downturn, many commercial property investors with interest-only mortgages found themselves in negative equity.
Exit Strategy Dependency
You must repay the full capital amount at term end. This typically requires either selling the property, refinancing, or using other funds. Each of these exit routes carries its own risks:
- Sale: Property values may have fallen, the market may be illiquid, or you may not want to sell
- Refinance: Lending criteria may have tightened, your circumstances may have changed, or rates may be higher
- Other funds: Personal or business circumstances may have changed
Higher Total Interest Cost
As shown above, interest-only costs significantly more in total interest over the life of the loan. You are paying for the flexibility, and that premium is substantial over longer terms.
Lender Review Risk
Most commercial mortgages include periodic review clauses (typically every five years). At review, the lender reassesses the property value, rental income, and your financial position. If conditions have deteriorated, the lender could require you to switch to repayment, reduce the loan balance, or potentially call in the loan entirely.
Refinancing Pressure at Maturity
When a five-year interest-only term expires, you face the reality of refinancing the full original balance. If property values have fallen, you may need to inject additional equity. If lending criteria have tightened, you may not qualify for the same LTV. This creates a refinancing risk that repayment borrowers largely avoid.
Who Does Interest-Only Suit Best?
Commercial Property Investors
Interest-only is particularly well-suited to investors who:
- Hold properties for income rather than capital growth
- Are building or managing a portfolio of multiple assets
- Want to maximise tax efficiency on rental income
- Have clear exit strategies through portfolio sales or refinancing
- Understand and accept the risks of non-amortising debt
Owner-Occupiers with Growth Plans
Business owners purchasing their own premises may benefit from interest-only during periods of business growth, when retaining working capital is more valuable than building property equity. However, they should consider transitioning to repayment once the business is established.
Shorter-Term Holdings
If you plan to hold the property for 5-10 years and then sell, interest-only makes particular sense. You benefit from the cash flow advantage during your holding period and repay the loan from sale proceeds. The total interest cost premium is smaller over shorter periods.
Who Should Consider Repayment Instead
- Borrowers approaching retirement who want to eliminate debt
- Those holding property for 20+ years with no plan to sell
- Borrowers uncomfortable with the exit strategy requirement
- Properties with strong cash flow that comfortably supports repayment payments
Current Interest-Only Commercial Mortgage Rates
Rates for interest-only commercial mortgages are generally the same as repayment rates from the same lender. The rate does not change based on repayment structure. As of early 2026, typical interest-only commercial mortgage rates are:
| Lender Type | LTV Range | Indicative Rate Range |
|---|---|---|
| High street banks | 50-65% | 5.00% - 6.25% |
| Challenger banks | 60-75% | 5.50% - 7.00% |
| Specialist lenders | 65-80% | 6.50% - 8.50% |
Key factors affecting your rate include:
- LTV ratio: Lower LTV = lower rate. The difference between 50% and 75% LTV can be 1-2% in rate
- Property type: Standard commercial (offices, retail, industrial) attracts better rates than specialist sectors (pubs, care homes)
- Tenant strength: Strong covenants and long leases improve rates
- Borrower experience: Established borrowers with track records access better pricing
- Loan size: Larger loans (1m+) often attract better rates due to lender competition
- Fixed rate term: Longer fixed periods may carry slightly higher rates
Lender Criteria for Interest-Only
Debt Service Coverage Ratio
Most lenders require a minimum DSCR of 1.25x on an interest-only basis, though some insist on 1.35x-1.50x. Many lenders also stress-test at a higher rate (typically the pay rate plus 1-2%, or a minimum floor rate of 7-8%) to ensure the property can service the debt if rates rise.
Loan-to-Value Limits
Interest-only LTV limits are typically the same as for repayment mortgages:
- High street banks: Up to 65-70% LTV
- Challenger banks: Up to 70-75% LTV
- Specialist lenders: Up to 75-80% LTV (in some cases higher with additional security)
Exit Strategy Assessment
This is where interest-only applications receive the most scrutiny. Lenders expect a detailed, credible exit strategy. Accepted exit strategies include:
- Property sale: With evidence that the property would achieve sufficient value to repay the loan
- Refinance: With realistic assumptions about future lending criteria
- Other asset sale: Evidence of other assets with sufficient value
- Pension drawdown: For borrowers with substantial pension funds
- Business sale: For owner-occupiers planning to sell the business
"I will refinance at the end of the term" is no longer sufficient on its own for most mainstream lenders. They want to see a realistic, detailed plan.
Property and Lease Requirements
- Unexpired lease term: Ideally well beyond the mortgage term
- Tenant covenant strength: Financially robust tenants preferred
- Rent review provisions: Upward-only reviews help protect income
- Property condition: Well-maintained properties in established locations
Borrower Profile
- Net worth: Demonstrable assets beyond the property being financed
- Experience: Track record of commercial property ownership or management
- Age: Some lenders cap borrower age at term end (typically 70-80)
- Alternative income: Ability to service the mortgage from other sources if the property is vacant
Part-and-Part: The Middle Ground
If full interest-only feels too risky but full repayment is unaffordable, a part-and-part structure offers a compromise. Part of the loan is interest-only and part is on a capital repayment basis.
A common structure:
- Interest-only portion: Up to 50-60% LTV
- Repayment portion: The balance above that threshold
Example on a 1,000,000 loan at 70% LTV:
- 750,000 on interest-only (up to 52.5% of property value)
- 250,000 on repayment over 25 years
- Monthly payment: approximately 4,634 (compared to 4,583 fully interest-only and 6,141 fully repayment)
This reduces your outstanding balance at term end from 1,000,000 to approximately 750,000, making the exit strategy more manageable while keeping payments close to the interest-only level.
Tax Implications of Interest-Only Payments
The tax treatment of interest-only commercial mortgage payments is straightforward and favourable:
Fully Deductible Interest
All interest paid on a commercial mortgage is deductible against rental income for tax purposes, regardless of whether the borrower is an individual, partnership, or limited company. This applies to both investment and owner-occupied commercial property.
No Section 24 Restriction
Unlike residential buy-to-let, commercial property interest relief is not restricted by Section 24 of the Finance Act 2015. Commercial property landlords continue to deduct mortgage interest at their marginal tax rate, making the effective cost of borrowing significantly lower for higher-rate taxpayers.
Capital Gains Considerations
Because interest-only borrowers retain the full loan balance throughout, they should be aware that capital gains tax will apply to any increase in property value when they eventually sell. However, this is the same whether the mortgage is interest-only or repayment -- the repayment structure does not affect CGT liability.
Corporation Tax for Limited Companies
Limited companies holding commercial property can deduct mortgage interest as a business expense, reducing corporation tax liability. The interest-only structure maximises this deduction annually.
Mitigating the Risks
Interest-only carries inherent risks, but experienced borrowers manage these effectively:
Build a Sinking Fund
Set aside a portion of the cash flow savings each month into a dedicated sinking fund. Even modest contributions build up over time and provide a buffer if property values fall or refinancing is challenging.
Make Voluntary Overpayments
Most commercial mortgages allow voluntary overpayments of 10-20% per year without penalty. Making occasional lump sum payments reduces your balance and exit strategy burden without committing to higher regular payments.
Regular Portfolio Reviews
Review your portfolio and mortgage positions annually. If property values have risen significantly, consider refinancing to release equity and reduce LTV. If values have fallen, take action early rather than waiting until the term expires.
Diversify Exit Strategies
Do not rely on a single exit route. Have a primary strategy (e.g., refinance) backed up by alternatives (e.g., sale, use of other assets). The more options you have, the more resilient your position.
Monitor Market Conditions
Stay informed about lending market conditions. If criteria are tightening or rates are rising, consider refinancing early rather than waiting until your term expires.
How We Help Clients Structure Interest-Only Mortgages
At Commercial Mortgages Broker, we help clients across the UK determine the optimal repayment structure for their commercial property finance. With access to the full market -- high street banks, challengers, specialist lenders and private banks -- we present the interest-only terms available and help you weigh the cash flow benefits against the exit strategy requirements.
Our team draws on direct banking experience to stress-test your application before submission, ensuring your exit strategy satisfies even the most cautious lenders.
[Get in touch](/contact) to discuss whether interest-only is the right structure for your commercial mortgage.
*Written by Matt Lenzie, Founder of Commercial Mortgages Broker. Ex-Lloyds Bank & Bank of Scotland.*