Impact of Bad Credit on Commercial Loans

The impact of bad credit scores on commercial loans has never been so severe. And we’re not just saying that so you read this article. As the commercial secondary market continues to take a beating and local banks that still lend off of their balance sheet cherry pick deals, borrowers credit score are an all too easy lending criteria to “pick on”.

Unlike a lot of the components in commercial underwriting, the borrower’s credit score is simple to calculate and very easy to categories. Compared to predicting future business trend, or calculating property valuing in a declining market for example, figuring out the borrower’s credit score only take a few minutes. If the score is outside guidelines, it’s a dead file. For example the vast majority of banks simply will not look at deals where the borrowers score is below a 680 now. A year ago 620 was questionable, maybe even “looked down” on, but still doable.

Improving ones score should be a huge priority for all borrowers. Much has been written on the topic (which we discuss on our website) but whatever strategy the borrower uses, if they decide to do it on their own or hire a firm to handle it for them, it should be taken very seriously.

For commercial loans with bad credit that do close, the borrower is now paying a huge price for the lenders leniency. Rates are often 2% – 8% higher than on typical bank loans. Prepayment penalties are often very high and restrictive as some lenders within this arena charge interest lock outs and the like. Loan programs are often shorter as well and many lender including the government’s Small Business Administration charge high fees. For example the SBA 7a program, which is their most popular commercial mortgage, charges 2.75% on the front of the loan… And that’s the governments program!

Bottom line – borrowers will save 10′s of thousands of dollars by rising that score and 10′s of thousands on transaction costs by not having to refinance out of short term loans that they where forced into due to personal credit scores. If you are in a position where you know you have to refinance your existing loan, perhaps it is ballooning or your existing bank is pressuring you to leave, get started on improving your score immediately as the impact of bad credit on your commercial loans is just too serious in this market.

Current Commercial Loan Rates

Commercial loan rates are essentially the combination of the underlying index and the margin that the funding bank or lender charges. Borrowers should be careful on the way that their term sheets are written in regards to quoted rates. Below are a few suggestions on how you can protect yourself against having your commercial loan rate increased (bait and switch) while in process.

First of all, an indexes commonly used in the commercial mortgage industry includes Prime and the 10 Year Treasury. Less well known indexes such as the 5 Year Swap or the FHLB indexes are becoming more popular.

The margin is where the bank makes its spread. It is a very complicated process for banks to figure out what to charge as they basically have to predict the future and take into account the probability of default, adequately cover their costs, and of course try to make a profit. At the same time the industry is highly competitive and they have to price out their loans “skinny” enough to be able to bring in new borrowers.

The combination of the margin and index is commonly referred to as the Effective Rate. It’s what the borrower will use to calculate their payments and what they normally think of when they ask for rate quotes. For example if a bank quoted you Prime plus 1% your Effective Rate would be 6% as prime right now is at 5%.

The main suggestion regarding not having your rate bumped up on you while your loan is in process is to have both the margin and index clearly written on the term sheet. The opposite is to just have the effective rate quoted with no mention as to either the margin or the index. If either or both go down for example, you would not know, and would not know that your rate should be lower. The lender could simply keep your rate the same and you would have no recourse or really any way of knowing.

A worse scenario would be to have your rate increase during process. Rate locks are rare in the commercial mortgage industry so it is possible for the funding bank to call you with the bad news that your rate will be higher. In fact, as of this writing 5/8/8, it’s not that uncommon at all, as banks are constantly rethinking what they can and what they want to lend on – due to the credit crisis. And many will have the attitude of, take it or leave it. More to the point though if the margin and index are not clearly known the lender could mention any margin or index when challenge to “cover” his story.

Get it in writing or assume they will try the bait and switch on your commercial loan rate.

Things to Remember About a Commercial Loan Workout

These times are the best times as any to take advantage of applying for a commercial loan workout since a lot of owners are having difficulties in applying for the refinancing of their debt obligations. Options like a commercial short sale and a commercial loan audit are just some of the effective solutions designed to help delinquent borrowers to become more financially stable. These arrangements help the property and business owner on a lot of things such as cutting down on interest and principal rates, improving the cash flow, and many others. The different kinds of properties that will benefit include office buildings, multi tenant buildings, motels, shopping malls, strip malls, and hotels.

A commercial loan workout that is successful depends on the business owner’s capability to maintain a steady cash flow to pay monthly premiums on time on each new loan terms. However, before a commercial loan workout is granted, the creditors or the lenders would first have to analyze the financial documents that they required the borrower to submit to them. This is for the lenders or creditors to determine whether or not a property owner would be capable of making the monthly payments required for the modified agreement. So, for a property owner to convince the lenders or the banks enough to approve the application, proper and solid documentation proving the owner’s financial difficulty would have to be submitted.

There are several types of lenders that the owners can do business with; however, the best choice would be the banks. Owners of these income-producing properties can apply directly to their banks or lenders; however, this may somewhat be a daunting and intimidating task so there are third party firms that, at a certain fee, will handle the negotiations and application process on the owner’s behalf. A commercial loan workout is favored by a lot of property and business owners because it offers them flexible options to pay off their obligations. These options include interest rates reduction, extension of terms on the original loan as well as lowering of the balance on the debt.

However, the vital step in the whole process of commercial loss mitigation and most importantly, commercial loan workout, is to get approved and get approved as quickly as possible. Now, in order to do this, a property owner who is applying must be well informed about the details regarding the procedure of approval as well as making sure that all necessary documents and paperwork are in place and ready to be submitted. You, as a business owner would need to have your own copies of the important financial documents that would be required such as tax returns, land and property statements, business proposals and plans, and others. Keep in mind that filing an application also has costs so it would be better to prepare yourself for any toward expenses. All in all, adjustments to the terms of the debt obligation would be very helpful for any property and business owner, all that is needed is to be approved for it.

90% Commercial Loans – Does This Really Exist?

Business owners as well as investors are constantly looking for way to increase their rate of return. One of the quickest way to do this in the commercial real estate industry is buy property with as little down as possible.

However banks and lenders make the rules and dictate what the minimum are for down payments. Currently as of this writing there are really only two viable options for straight 90% commercial loans. And those options are restricted to the SBA and a couple of CMBS lenders that are still in business. These loans are only for business owners and not for investors.

There are no 90% commercial loans for investors currently in the market. There are ways to structure 90% financing which you probably already know – seller seconds and cross collateralization. With seller seconds you’d get the seller to hold say 10% of the sale price as a loan that sits in second lien position. Most sellers are not willing to do this and most banks do not allow any type of financing to sit behind their loan. So just because it’s a well known technique doesn’t mean it’s easy to get done.

With cross collateralization the funding bank improves their position by tying more collateral in the loan by tying up another property or really any other assets the borrower has. Cross collertization is common but not to get to 90% financing. It’s normally used as a way to get typical, conservative loans done.

Going back to 90% commercial loans for businesses – The SBA programs are the most common answer for business owners to keep as much cash in their pockets as possible. There are two types of SBA loans that are important. The SBA 7a and the SBA 504.

The SBA 7a loan is geared primarily for loan amounts under $2,000,000 while the 504 is geared towards loans between $2,000,000 to $7,000,000. Both go to 90% financing and both can be set up for 90% loan to cost financing.

90% loan to costs means you take the entire project cost and finance that total amount. For example, say you’re purchasing a property at $1,000,000 and have $200,000 in build out and $100,000 of equipment. Your total project costs would be $1,300,000 and you could finance 90% of this amount and would only have to bring $130,000 to close.