Private Lending School
Lesson 2: Interest Rates – All that glitters is not gold
Lesson 1 I focused on term sheets. This post I will focus on interest rates and costs.
This topic hit home to me this week when a broker called me about a deal and asked me to price a loan, which I did, to which he called me and said "I have a cheaper option".
"That’s ok" I said, but I was curious. "What was it?" I asked. The broker advised, "they are giving it to us for 0.2% per month less interest rate for a 2 month term". My quote was a 3 month term.
The alarm bells rang. Here was a client whose exit was selling a property, being pushed into a 2 month deal, which effectively gave them only 2 weeks to sell and a 6 week settlement period.
This structure made no sense to me and while it was the term that the borrower asked for, it was not what the borrower needed. All the risk now sits with the borrower. Extension of the loan is at the discretion of the lender. Some private lenders will write this loan as a loss leader, knowing it’s not the rate I want but I will get it at the back end of the deal.
What the client needed was a 3-4 month loan (maybe the borrower asks for slightly more funds for interest coverage), interest capitalised for 2 months with a minimum term of 2 months and a term allowing them to repay early.
We are currently in evolving times in terms of property selling periods and risks associated with purchasers completing on the purchase. Be alive to this when setting your deal and avoid the shiny rates with shark like terms.
Tip 1: Be aware that a lower interest rate doesn't necessarily mean the best offer for your client. Most clients will be rate focused but it is in their best interest to look at the loan structure as a whole and determine the risks involved.
Does the loan term facilitate their proposed exit strategy? What buffer have you provided for possible delays? Make sure your client can adhere to repayment deadlines or finance the costs if they can't.
Keen to know more, check out the following links:
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