Commercial Loans: Choosing a Repayment Structure that Fits the Deal

Lots of commercial lenders have a style they like to use when setting up their loans.  For lenders that might be considering a deal, and want to tailor the financing to match the situation, here are some examples of how commercial loans are often structured to match the situation.

Interest rates

Increasing Rates – Example: every year the interest goes up one percent - interest is at 5% the first year, 6% the second year, and 7% the third year.  Sometimes the interest might jump from 8% to 13% after a year, and then 14% after another year, etc.

Why might you do this?  If the deal is expected to take a set period of time, financing costs are lower if the deal happens on schedule.  Interest rate hikes can add pressure conclude a deal expeditiously if the cost of delay will be higher.  If you want to be out of a deal by a certain date, it can add incentive for a borrower to seek alternative funding once they’ve completed their initial startup and will have access to better terms.  The rate increases might be related to relative risk – such as depletion of the borrower’s operating funds as the work progresses on a project.

Balloon Payoff

If the borrower only needs to money for a short period of time, or the loan is predicated upon a lump sum receipt, the loan may have a set final date or be completely open ended.  It is common for the borrower to make interest payments over time, but there are also situations where the interest accumulates unpaid and paid off with the rest of the loan.

Examples of this type of loan include real estate deals, where the loan will be paid in full when the real estate is sold.  Some financing during lawsuits might cover attorneys’ fees during the suit and interest builds on the amount of the loan, and when the settlement is finally awarded, the loan and its interest are paid off in their entirety.  If the ending is set in stone, or completely unknowable, you can structure your contract to define how you will be compensated during the loan’s lifetime and then again at its conclusion.

Progressive Disbursal

It is super common, on deals where expenses are incurred incrementally, that principal be granted to the borrower on an as-needed basis.  The disbursals might be set on a specific timeline, contingent on the achievement of defined milestones, or provided on an as-needed basis.  When setting up the deal, put it in writing what the exact criteria for disbursal of funds will be if all the funds are not provided up-front.

Because there’s no one correct way to loan money to someone, feel free to tailor your deal to your tolerance for risk and your level of trust in the other party.  The one with the money gets to set the terms, after all.  Make sure the terms work well for you.

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Tell us your tricks for tailoring commercial deals in the comments!