Beware Misleading Bad Credit Commercial Loans

Misleading bad credit commercial loans! There are all sorts of lenders and loan types for commercial borrowers – including bad credit commercial loans.

In most cases, the rate reflects the risk and everything is very transparent. However, sometimes it can cost the inexperienced borrower a fortune and potentially ruin their business. This is particularly a risk for those looking for a bad credit commercial mortgage or for businesses which have difficulty proving income. Look out for bad credit commercial loans.

Tier 1 Commercial lenders

There are around half a dozen active lenders – often banks offering great rates. They mainly like to lend to owner occupied businesses secured on commercial premises. Lenders are wanting borrowers with a good track record and a good credit history. They apply more stringent affordability criteria, and are less keen on lending on investment property for retail and non-essential businesses.

Tier 2 Commercial lenders

There are 3 or 4 lenders which try to pick up the applications which fall out of tier 1. They still offer decent rates, but perhaps are a little more flexible on affordability, the property types and sectors they will accept.

Tier 3 Commercial lenders

There is a good choice of lenders, all with particular niches to accommodate less affordability, less attractive property types and borrowers with less experience in the commercial sector. These lenders are also generally more accommodating if the rental income is from retail premises or offices. Consequently, they pick up a lot of business which falls out of tier 1 and 2.

As a potential commercial loan borrower, don’t make assumptions which category your application fits in. Once we understand an application and the borrower’s background, we will try to exploit gaps in lenders criteria to get the best terms available. We can often get cases accepted in tier 1, which initially might appear to be tier 3.

Your bad credit or non status commercial loan could cost far more than you think

In this article, I want to focus on a number of lenders, which operate on the edge of commercial lending. They might offer loans when other more mainstream lenders won’t.

They will accept bad credit and income projections. If there is sufficient equity in the property being offered as security, they will go to great lengths to try and accept the application.

That’s great news for many borrowers, but they need to know what they are getting into. Some lenders often quote flat rates rather than APRs.

Difference between flat rates and annual rates

● With an annual rate loan, the interest is charged on the balance as it reduces. These are the types of loans which often quote an APR
● With a flat rate loan, all interest is added at the start – this costs the borrower more.

So, whilst the rates may sound the same in a conversation or on documents, the flat rate is roughly double the annual rate. You could end up paying double the amount of interest.

Flat rate vs annual rate loans – amount of interest paid (Example – approximates for illustration only)

Let’s take a traditional £100,000 commercial loan at 4% x 120 months (10 years). It would cost around £1010 per month. That’s a total repayable of £121,440.

That’s a cost of £21,400 in interest over 10 years.

Now let’s look at a flat rate loan at 4% over the same term. Remember the interest is calculated on the initial advance and added to the loan at the start.

£100,000 x 4% = £4000 interest per annum.
It’s a 10 year loan, so the total interest will be £4,000 x 10 = £40,000.

The initial loan is £140,000. That’s roughly double the amount of interest on the standard annual rate loan. The repayment on £140,000 over 10 years would be £1166 – maybe that doesn’t sound too much more per month. However, £18,500 extra interest over the term should get anyone’s interest – if its explained to them.

However, the BIG difference is how early repayment charges are calculated

Flat rate versus annual rate loans – early settlement charges (Example – approximates for illustration only)

On a traditional commercial loan, you will be told if there are early repayment charges. Often, a percentage of the balance at the time you settle. Foe example, 2% of the balance if you settle in the first 3 years.

On flat rate loans, they work much like car finance or a lease agreement. If you ask if there are early repayment charges, some operators proudly say there are none.

That’s because if you sign up to a 5 or 10 year deal – you are expected to make all the repayments under the agreement. Indeed, there are no early settlement charges because you are expected to pay the lot.

To put this in context – rough figures for illustration:

On a traditional £100,000 x 10 year commercial mortgage, at a rate of 4%, if you settle at the end of the second year, you might be charged a 2% early settlement charge. The balance may have dropped to £84,000 so you could be charged 2% of £84,000 to settle the loan. This adds up to £1700 approximately.

On a flat rate loan, all of the interest will have been added to the loan at the start and you will be required to pay all the remaining payments under the agreement. Remember, because all the interest was added, you owed £140,000 at the start of the loan.

After two years you ask to settle the loan.

Bad news – you still have 8 years or 96 repayments to make at approximately £1166 per month.
That’s a cost of £111,936 unpaid interest you will be asked to pay to cancel or repay the loan.

Most lenders operating this way will give a small discount off this amount. However, it’s a “round of drinks” compared to how much you could be asked to pay.

Many people will be used to this type of agreement, as it is mainly seen in car finance or for buying items such as photocopiers. Normally, you keep the item to the end of the term, so early repayment is not an issue.

However, in the commercial mortgage sector, it’s easy to get caught out.

Please Note

Most lenders do not operate this way. A reputable broker will explain the difference, if this type of flat rate agreement is open to you.

It’s not a bad product. For someone who doesn’t meet the mainstream criteria, perhaps because they are just getting their business going, it may be a suitable means of paying off a vitally needed loan over 5 years.

We are providing this information as a warning of what could happen if you don’t fully understand the type of agreement you are entering. Choose a reputable broker who is a member of FIBA who will explain it to you so you can make an informed decision.

Otherwise, buyer, beware

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