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Not All Loan Terms are Created Equal

Several years ago a friend of mine in the real estate business, in an attempt to make a point, said he would pay me any price for my home I asked with only one condition, he got to pick the terms. I had purchased my home for $200,000 the previous year, so I decided I would call his bluff. I told him, “I want $1 million for my house”. Without any hesitation he stuck out his hand
and said to me, “Deal!”.

I knew there had to be a catch, why would anyone pay a million dollars for a house worth approximately $200,000. I soon learned the reason. He said, “I’ll pay you a million dollars for your home, but the terms are, a dollar a year for a million years!”

Loan Terms

He had made his point. While this example is on the extreme side, quite often the terms of a transaction can be far more important than the negotiated price and the price is often what most people focus on.

When it comes to a loan, the interest rate can often be considered the price of the loan. Yet, just like with the sales transaction described above, the terms of a loan can be equally, if not more, important than the interest rate itself.

Most institutional lenders, such as banks and credit unions, usually don’t make loans to churches. However, occasionally some do. This is when the terms of that church loan come into play.

It is not unusual for an institutional lender to start the loan out with what is known as a “teaser rate”. A teaser rate is an interest rate which is very low during the first period of the loan, say the first year. After that period has passed, the interest rate is adjusted and that adjustment will most certainly include an increase in the interest rate. When the interest rate increases so do the monthly payments on the loan.

While most of these type of adjustable rate loans have a cap as to how high the interest rate can go, a church still can’t be certain what the interest rate and/or the monthly payment will be down the road. This can make planning the church’s budget considerable more challenging.

Adjustable (or variable) interest rate loans are quite common with institutional lenders. But the adjustable interest rate is not the only area of concern for a church. There is also the length of the loan itself. Almost all bank loans to churches are short in duration, say three to five years. As you might imagine, paying off a large loan in only three to five years can be next to impossible for almost all churches. The banks know this and they use this fact to their advantage.

If a loan is written for a short term, but the loan is not paid in full during that period of time, the result will be a balloon payment due at the end of the term.

What happens at the end of the term when the balloon payment comes due? You guessed it,the church will need to refinance the loan and that loan will likely be replaced with another short term loan. And then what happens at the end of that second loan? You guessed right again, the church must refinance that loan as well.

Do you start to see a pattern here? The church can find itself in a situation where it must refinance its loan every three to five years over and over and over again with no real end in sight. So, I ask you, how good does that low teaser interest rate at the beginning look now?

Even a bank loan which might have a fixed interest rate, the monthly payments will still be based on a longer term, say 30 years, but with a “call date” (maturity date) in 5 years. This is known as a “30 due in 5”, where the monthly payments are based on a 30 amortization but with a balloon payment due in 5 years. As already discussed, that balloon payment will need to be refinanced. If each time the church refinances with a bank they receive another “30 due in 5”, it doesn’t take a genius to realize the original loan will never, ever be paid in full. It will just go on and on and on.

So, what is the solution to this dilemma? It’s very simple. It’s a fully amortized, fixed interest rate loan!

By far the most common loan arranged by BDM Mortgage Services (BDM) is a 15 year fully amortized loan with a fixed interest rate. In other words, a “15 due in 15”. For those not familiar with the term fully amortized, that simply means there is no balloon payment due at the end of the term. With no balloon payment to deal with, there will never be the need to refinance the loan ever again. It can be considered a “one and done” type of loan.

Other loan terms are also available at BDM which can be tailored to a specific church’s needs and concerns, but we alway start the conversation with a fully amortized loan and go from there.

There is one more item a church needs to be aware of and that is a possible prepayment penalty on a loan. This is where the church is charged a penalty for paying the loan off early. That’s right, the church can’t pay the loan back early without a penalty! Wow, doesn’t that sound crazy? The church is basically locked into the loan.

At BDM, none of the loans we arrange have a prepayment penalty. With no prepayment penalty, the church can pay extra, or pay the loan in full, at any time without penalty. This provides the church with more options. It can pay extra on the loan if it chooses to or it can simply pay the normal scheduled monthly payments. Either way works.

By the way, should the church choose to pay a little extra each month, that 15 year fully amortized loan could be cut down to a 12 year loan, or a 10 year loan or even less. The reason for this is, the more the church pays towards the principal balance each month, the less it pays in actual interest dollars. This is because each month’s interest is calculated on the previous month’s principal balance. As the principal balance goes down, the less the church will be paying in interest dollars that month and every month thereafter. The less that is paid in interest each month, the more money will be available to be applied toward the outstanding principal balance. This has a multiplying effect as time goes by which can reduce the actual length of the loan by several years.

Not only does BDM encourage a church to consider a fully amortized loan when it applies for financing, we also encourage the church to pay extra on that loan whenever the church’s budget allows for it.

For a further explanation of available loan terms, or for any questions you or your church may have, feel free to give us a call at (800) 439-9551.

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