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Bad credit commercial loans – Don’t get caught out

17th September 2021

By Alex Walker

Bad credit commercial loans are available but be warned. Some are structured in a way that you will pay thousands more in interest.

In most cases the rate on bad credit commercial loans reflects the risk and everything is very transparent. But sometimes it’s not and this can cost the inexperienced borrower a fortune and potentially ruin their business.
This is particularly a risk for those looking for bad credit commercial loans or for businesses which have difficulty proving income

Let me give you some context

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. They 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

Here 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 and the property types and sectors they will accept.

Tier 3 Commercial lenders (some consider bad credit commercial loans)

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 where the rental income is from retail premises, offices. Consequently they pick up a lot of business which falls out of tier 1 and 2.

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

Take Care – your non status or bad credit commercial loans could cost far more than you think

In this post I want to focus on a number of lenders which operate on the edge of commercial lending and will offer bad credit commercial loans when other more mainstream lenders won’t.

They will accept bad credit. They will accept income projections.
If there is sufficient equity in the property asset 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 as some lenders often quote flat rates rather than APRs.

Difference between flat rates and APR’s

● With an APR loan the interest is charged on the balance as it reduces
● With a flat rate loan all interest is added at the start – this costs you more

So whilst the rates may sound the same in a conversation or on documents, the flat rate is roughly double the APR in most cases and you could pay double the amount of interest

Flat rate versus APR – amount of interest paid – (Example – approximates for illustration only)

Let’s take a traditional £100,000 commercial loans at 4% x 120 months (10 years) which would cost around £1010 per month
That’s a total repayable of £121440
Less the amount borrowed of £100,000 – that’s a cost of £21400 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

So the initial loan is £140,000 and 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. But £18500 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 APR – 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 – eg 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 I have heard 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 – again 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 year two you might be charged a 2% early settlement charge. ( I should add that most tier 1 lenders don’t charge any early repayments charges). The balance may have dropped to £84,000 so you could be charged 2% of £84,000 to settle the loan which is £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 virtually 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.

That’s more than you borrowed in the first place and £26000 more than the amount to settle the APR loan with a 2% early repayment charge.

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

Many people will be familiar with this type of agreement as it is mainly seen in car finance or for buying items such as photocopiers – and 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 and a reputable broker will explain the difference if this type of flat rate agreement is the only one 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 into. 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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