If you are reading this article the chances are that you have encountered a huge amount of mind-numbing jargon in applying for a business loan.
This article is designed to simplify the jargon and help borrowers better understand the process around applying for business loans.
Appraisals are only intended as a guide to pricing and can be requested from real estate salespeople. They are estimated from knowledge of the local area and recent sale prices and should only ever be used as an estimate of price.
Assets are things that you own. These include cash or something that can be converted into cash such as property, vehicles, equipment and inventory. Asset-based lending is a loan secured by collateral (assets).
A bridging loan is designed to help businesses “bridge” the gap between different funding options. For instance, a business could use a bridging loan while waiting for other funding arrangements to be finalised.
Many lenders will only lend to borrowers for business purposes. Loans that are not for business purposes will be governed by The National Credit Code, which applies to all credit contracts entered into on or after 1 July 2010, provided the following conditions are met:
- The debtor (i.e. borrower) is a natural person or a strata corporation;
- The credit is, or is intended to be, provided wholly or predominantly:
- For personal, domestic or household purposes; or
- To purchase, renovate or improve residential property for investment purposes; or
- To refinance credit that has been provided wholly or predominantly to purchase, renovate or improve residential property for investment purposes.
The National Credit Code does not apply if the credit provided (i.e. the money loaned) is provided wholly or predominantly (i.e. over 50%) for business purposes, or for investment other than residential property investment.
A caveat is a document lodged with a government body which notifies third parties of an interest in a property. A caveat also acts to prevent other dealings (such as mortgages and transfers) from being lodged on the property. Many lenders will advance funds to a borrower based on a caveat, and then move to register a mortgage on the property.
Credit Rating / Credit Score
A credit rating or credit score is a numerical score representing how trustworthy your reputation is as a borrower. Your credit reliability rating is usually a score that lenders and other organisations use to determine whether an individual or business represents a financial risk.
There will be a separate score for both business and personal credit files. A business credit score will take into account commercial indicators, such as registered defaults, potential loan enquiries or any external administrations registered against a business.
Traditional lenders will rely heavily on a borrower’s credit score in assess a loan application and also calculating total loan amounts.
Creditors are people and companies to whom a borrower owes money. Before advancing funds, a lender will seek to gain a full understand of the amounts owed to creditors. This is because they want to make sure there is sufficient in a property in order to properly secure their loan.
A default occurs when there is a failure to perform some obligation (for example, a missed loan repayment) under a loan agreement. The borrower will generally be allowed a period of time to remedy the default. If the default remains unfixed at the end of this period it will become an event of default. Consequences of events of default are provided for in the loan agreement and should be checked over by prospective borrowers.
In relation to property, equity is the difference between the market value of, and the current amount secured by, the property. Traditional lenders will look to the equity in a property before making a decision on whether to loan money to a borrower.
An exit strategy allows the lender to understand how a borrower plans to repay the loan. Possible exit strategies include using working capital to repay the loan, refinancing, or selling the security property. Lenders will commonly ask for an exit strategy in their assessment of business loan applications.
A loan agreement (or facility agreement) sets out the terms on which money has been lent. Loan agreements are complex documents, but the following is a guide of the important things to consider:
- Interest – basic loan agreements normally used a fixed rate.
- Default Interest
- Secured or Unsecured
Loan to Valuation Ratio (LVR)
The Loan to Valuation Ratio (LVR) is a lender’s way of ascertaining the true financial value of property. LVR is actually pretty simple – it is just the loan amount divided by the value of the property. For example, the LVR of a $200,000 loan on a $267,000 property is 74.9%. LVR is determined by the valuation conducted by the lender, and not the purchase price paid for the property. There may be a difference between a valuer’s price and the purchase price.
The lender in a mortgage transaction.
The property owner in a mortgage transaction.
A Non-Bank Lender (sometimes referred to as an alternative lender) is a financial lender that is not a bank. These lenders are typically much smaller than the mainstream banks. Blue Streak and its panel of lenders are examples of non-bank lenders. Non-bank lenders might be more expensive than traditional bank lenders, however they are able to process applications more quickly and require less burdensome documentation. Non-bank lenders also offer greater flexibility to work around a business’ funding requirements.
This covers any property someone can own excluding land, buildings and fixtures. Goods, plant and equipment, cars, boats, planes, livestock are example of personal property.
Personal Property Security Register (PPSR)
The PPR provides a single national noticeboard of security interests in personal property.
Security (also known as Collateral)
In most cases a lender will ask you to secure the business loan using some form of asset that you own. This acts as security for your repayment obligations to the lender. The most common asset for a business loan is property (i.e. residential, commercial and rural land). A lender can take possession of and sell the Security in the event that a loan cannot be repaid.
A refinance is when a borrower takes out a new loan to pay out an existing loan on their property.
A formal valuation can only be conducted by a qualified valuer. A formal valuation will take into account a variety of factors, including:
- The location of the property
- The building structure and its condition
- Building/structural faults
- Features of the home
- Caveats or encumbrances on the property
- Local Council zoning
- Additional features of the property
Valuations are required when a definitive value for a property is needed. Many lenders require formal valuations in their assessments of loan applications.
The valuer will provide a written report detailing the value of the property along with explanations of how this value was reached.
An Unsecured Loan is when the borrower takes out a loan with a lender over a fixed period without providing security. Unsecured loans usually have higher interest rates due to the higher risk taken on by the lender. Many businesses opt for unsecured loan options when seeking smaller loan amounts.
Blue Streak does not accept applications for unsecured loans as all of its panel lender clients require security.
A Secured Loan requires the borrower to use an asset as collateral securing the loan. As discussed above, these assets are usually property but can be anything from a vehicle to business equipment.
Secured Loans generally come with lower interest rates than Unsecured Loans. However, should the borrower fail in its repayment obligations, the lender can move to seize and sell the security to recover the debt.
Working capital is the cash available to a business for day to day expenses. It refers to the difference between a business’ current assets and its current liabilities. Working capital is a reflection of a business’ current short-term financial health. Small businesses with cyclical sales cycles will often have periods of high sales activity followed by quieter periods. Businesses in this situation commonly take out working capital loans during these slower periods.