By Paul Long August 2016
When I talk with business owners there are always questions and assumptions that get brought up when talking about loans. Most Americans understand basic consumer loans, there are your traditional term loans, lines of credit and mortgage loans. Now even though businesses have those same types of loans they can look very different. Here are some of those differences.
Many consumer loans these days are done on a scoring system. Banks, car dealerships and vendors all use programs where they submit your social security number and get your credit score, analyze your income and the computer spits out a yes or no within minutes.
For businesses though the most common thing I hear is “Geeze there is a lot of paperwork” and yes depending on the bank and product, there can be. Businesses are complicated and it is the banks job to make sure that we are making a good loan. We have to understand how your business lives and breathes so therefor we will ask for more documentation….sorry.
Loan Terms- Mortgages vs Commercial Mortgages
Let’s take a look at a mortgage loan. On the consumer side you want a loan to purchase a house. You can get a great fixed rate for 30 years. This is because most loans are sold to Fanny Mae and Freddie Mac. These are government sponsored programs that allow homeowners to get low long term rates. Without those organizations there would be no 30 year fixed rate. When banks lend money on a fixed term they are taking the interest rate risk. For example if you get a 4% fixed rate and then rates jump up to 9% you are getting a deal and the bank is losing money.
On the business side when dealing with Commercial Mortgages the terms are different. You will never find a 30 year fixed rate and term on a commercial mortgage. Why? Because there is no government sponsored program like Fanny Mae and Freddie Mac that can guarantee those rates, therefor banks have to determine their own interest rate risk. This is why most commercial loans have a 5 year fixed rate with a 10 year maturity, but the payments are based on 25 or 30 years.
Also when comparing terms on mortgages consumer mortgages have no balloons (usually) and no renewal periods (thank Fanny and Freddy for this too.) On commercial mortgages a bank is going to want to see how the property is doing after 10 years. Can you still afford the payment? Is the building still worth at least what the mortgage balance is? These terms make the bank feel better about the loan but can also cause some issues with the borrower if your situation had changed since you took out the original loan.
If you look into the consumer mortgage market in Canada they run there mortgage loans like we run commercial mortgages here in the USA.
Lines of Credit
Getting a line of credit for you personally is usually done by a scoring model as described above. There are no conditions on how you use the funds or when you pay them back. In most cases if a borrower wanted to have a line of credit and borrow $10,000 and make minimum payments for 5 years, then that is no problem. There are no renewal periods so you don’t have to worry about the bank calling the note. However, if you have a large downturn in your credit score chances are a bank will “term out” your line of credit. Term out means the bank will turn off any available credit and turn what you owe on the line into a loan where you make fixed payments until the balance is paid.
On the business side lines of credit are pretty risky to a bank. Most banks want to see a borrower “rest” their line of credit for a certain amount of time each year. A “rest” means that the balance on the line must be at $0.00 for a minimum of at least 15 days or the line will not be renewed. There are also terms on a line of credit where the bank will re-underwrite the line each year or 2 to make sure that the source of repayment is still solid.
Overall make sure to ask your banker questions when applying for a loan. You are signing on the dotted line so make sure you know what you are signing. It is also our job as a lender to make sure that you are informed and making the best decision possible too.