Commercial versus residential security: what actually changes

Two things get confused constantly. The purpose of a loan is what the money is used for. The security is what the lender can sell if the loan is not repaid. They are independent of each other. A loan used entirely for business can be secured by the family home, and a loan used for a residential purchase can, in some structures, be secured by commercial property.

Which property you pledge changes almost everything downstream: how much a lender will advance, how long the term runs, how often the facility is reviewed, what happens if the value moves, and which body of law governs the contract. Understanding that before you choose is worth considerably more than shaving a fraction off the rate.

Security

The property the lender can sell if the loan is not repaid. It says nothing about what the money was used for.

Purpose

What the borrowed money is applied to. This is what decides whether consumer credit law covers the contract.

Business purpose declaration

A signed statement that the credit is wholly or predominantly for business. Signing it takes the loan outside the National Credit Code.

Covenant

A condition the borrower has to keep meeting during the loan, such as a maximum loan-to-value ratio. It is tested at review, not only at settlement.

Cross-securitisation

Two or more properties held as security for the same debt. Selling one later needs the lender's agreement and often a partial repayment.

Vacant possession value

What a commercial property would fetch with no tenant in it. Lenders assess this alongside the leased value, because it is what they would be selling.

A residential valuation is a comparison exercise. The valuer looks at what similar properties nearby have recently sold for, adjusts for condition, land size and improvements, and arrives at a figure. In an established suburb with regular turnover that is a reliable process and a short report.

A commercial valuation is an income exercise. The valuer establishes the property's market rent, deducts the outgoings the owner bears, and capitalises the net income at a yield drawn from comparable sales of similar assets. The lease is part of the security. A long lease to a strong tenant supports a higher value than the same building standing empty.

• Tenant quality, remaining lease term and option periods all feed the number. A lease expiring in eight months is a risk the valuer prices in.
• A vacant possession value is usually assessed as well, because that is what the lender would be selling if the tenant left.
• Specialised assets such as service stations, childcare centres, hotels and purpose-built medical premises are valued on their trade and treated more conservatively, because the buyer pool is small.
• Commercial reports take longer and cost more. Budget for both when you plan the timeline.

Why the valuation basis drives the advance

Because a commercial value rests on a lease and a yield, and both can move, lenders generally advance a lower proportion of a commercial valuation than a residential one. That is not a lender being awkward. It is the volatility of the underlying number. The same borrower, seeking the same amount, can need materially more commercial property behind the deal than residential property.

Where the business owns its premises, or a director holds a commercial investment, that property is often the right security for business borrowing.

• It keeps the family home out of the transaction, which changes the household's exposure and, frankly, the conversation at the kitchen table.
• Rental income from the property can support servicing in its own right.
• It aligns the security with the purpose, and some lenders show more appetite for a deal structured that way.
• Where the business occupies the premises, the lender can see the connection between the asset and the trading it supports.

The trade-offs are real. A lower advance against the value, a shorter term, more covenants, more fees, and a slower and dearer valuation. On a smaller loan those costs can outweigh the benefit, and it is worth pricing both versions before you commit to either.

For many trading businesses, residential equity is simply the cheapest and deepest pool of security available, and pretending otherwise helps nobody. A refinance of the home that absorbs tax debt and unsecured business debt can materially lower the monthly cost of carrying the same money.

That is a genuine benefit, and it comes with a genuine cost we will always say out loud. Debt that was unsecured becomes secured against where your family lives, and short-term debt becomes long-term debt. The rate falls; the total interest paid across the full term can rise, because the term is longer. Both of those sentences are true at once, and a decision made without both of them in view is not an informed decision.

• Model it over the term you actually intend to hold it, not over thirty years by default.
• Where the lender allows it, split the consolidated portion onto a shorter term so it is not amortised across three decades.
• Make a plan for whatever created the balance. Consolidation without that plan reproduces the same balances in two years, on top of a larger mortgage.

1. 01What proportion of the valuation are you lending, and what happens if a later valuation comes in lower?
2. 02Is there a loan-to-value covenant, and what are my rights if it is breached while every payment is current?
3. 03What is the term, and is there a review date that falls before the term ends?
4. 04Who pays for revaluations, how often can you order one, and can I order one?
5. 05Is this contract regulated credit, and are you asking me to sign a business purpose declaration?
6. 06What are the default provisions, and what notice do I get before enforcement?
7. 07If any portion is fixed, how are break costs calculated if I repay early?
8. 08Which external dispute resolution scheme covers this facility?

Write the answers down. A lender that will not put these in writing has told you something useful about the facility before you have signed anything.