There are certain things your banker isn’t going to tell you. For October, learning these tips and traps that can save you time, money and headaches down the road.
Tip No. 15 – Get New Money on Existing Loans
On a real estate loan, you can’t get new money after the loan is fully funded in most states. Let’s look at what that means: Say you get a $500,000 loan and it funds. You make payments for 3 years, leaving a balance of $350,000. Now, even though you have paid off $150,000, you can’t go back and get $150,000 in “new money.” The only way to get that $150,000 is to take out a new first lien loan or a second lien loan with all the accompanying fees and costs.
If you want to get revolving money on a real estate loan, take the proceeds and pledge them as collateral on a line of credit (LOC). Then you can pay and borrow, pay and borrow, etc. An additional huge benefit is that most LOCs are only for one year, but this one will always be renewed – so long as the collateral is healthy.
Tip No. 16 – Earn Interest on Your Collateral
When you use cash as collateral for a loan, have the bank pay you whatever it wants on the CD and charge you one point more for your loan. That way, the loan is costing you only one percent, because the bank is essentially paying you interest on the collateral.
In addition, when you use a CD as collateral on a loan, consider where you want the interest from that CD to be paid. Often it’s added back into the CD, which will increase the interest you receive, but then it can’t be used to go toward the interest you’re paying the bank. Consider having that interest paid into a money-market account, then using it to make the payment on the loan that the CD secures. Ron has an arrangement like this, and it leaves his net borrowing cost at one percent.
Tip No. 17 – Watch for Prepayment Penalties and Hedges
Check your real estate loan documents carefully. Laws vary by state, but in many, the lender can charge you a pre-payment penalty if you pay your loan off early. This can be a pretty big fee, so think carefully before agreeing to it. As previously mentioned, Ron recently paid off a loan that he didn’t realize had a pre-payment penalty in it. The cost was $125,000 on a $1.5 million loan – and he only paid it off to refinance it. (At the same bank!)
Also, banks may hedge or match fund your loan. That means they “match” your loan with a funding source, or hedge it in the markets that the rate won’t go up or down too much to protect their exposure on rates. It’s pretty complicated (too complex to explain fully here, but just ask if your loan is being hedged or match funded and what the implications might be to you. They may insist on a pre-payment penalty because they can’t “unwind” the hedge or match funding without a penalty. For instance, if you are paying seven percent interest, and you pay off early, they may be in an environment where they can only loan the money at three percent, so they want to be made whole or not have the risk associated with the difference.
Ron adds, “OMG! I recently encountered a car loan with a prepayment penalty in the boilerplate. I was infuriated, but couldn’t change it. Though I say toiling over the boilerplate is an exercise in futility, you should make sure there isn’t anything there unexpected or unusual. I’ve NEVER seen a prepayment penalty on a car loan. You are likely to wreck or want to sell a car before the loan is paid off, so this can be important. The banks’ attorneys are always coming up with things to add to the boilerplate based on isolated issues and lawsuits, so be it, and the banks of course are always looking for new sources of income. This one is bound to creep into more loans, that fee is immediate income, whereas many of the fees like origination fees must be amortized over the life of the loan for the lender.”
Remember only you can make business great!
Ron Sturgeon, founder of Mr. Mission Possible, small business consulting, combines over 35 years of entrepreneurship with an extensive resume in consulting, speaking and business writing, with seven books published. A business owner since age 17, Ron sold his chain of salvage yards to Ford Motor Company in 1999, and his innovations in database-driven direct marketing have been profiled in Inc. Magazine. After the repurchase of Greenleaf Auto Recyclers from Ford and sale to Schnitzer Industries, Ron is now owner of the DFW Elite Auto suite of businesses and a successful real estate investor. Ron is a web expert, but he is also an expert in helping all types of small businesses become more successful and more profitable. Ron can be reached at 5940 Eden, Haltom City, TX 76117, 817-834-3625 or by email at rons@MrMissonPossible.com.