Sometimes paying more is the smart option!
July 10, 2018
Bank funding is typically the cheapest option for commercial loans. But not all commercial loan scenarios qualify for a bank loan. Enter short-term finance!
Savvy brokers are discovering that diversifying into commercial lending can be highly lucrative. They’re also realising that short-term lending is an integral part of their suite of lending solutions for business borrowers.
Cost versus lost opportunity
Yes, short-term finance is more expensive. But let’s put that into context. What would the scenario look like if a loan wasn’t achievable? An inability to move forward on a project, missing an opportunity to purchase stock at a bargain price or remaining an also-ran because bank funding for an expansion falls through would all be measured as expenses.
As Platinum Executive, John Broadway says:
“The true cost needs to be rationalised by assessing what the opportunity lost cost would be if short-term funds are not accessed. It can’t be gauged by referring to the absolute rate of short-term funding.”
If funding isn’t secured, what project won’t be completed, what sale will fall through, what deposit will be lost or which options will expire? Best business practice is about weighing up the costs versus the benefits of all options. If the financial gain from being able to realise a business goal exceeds or
equals the cost of short-term funding, a short-term loan is a sensible and smart option.
The role of short-term loans is to provide an often crucial, cash injection to enable businesses to weather cash flow crisis such as paying creditors, purchasing stock, paying the ATO and providing working capital or bridging funds for construction and development.
What determines the cost of short-term funding?
The price of short-term finance relates directly to cost and risk.
- Short-term funders finance loans from funds obtained from shareholders and private and corporate investors. Banks generally fund loans through their retail or wholesale depositor base. Investors who put money into short-term finance want a better return than they can get in the bond market or a bank savings account due to the inherent risks.
- A short-term loan that is processed and paid out in a matter of days, often on the basis of limited information, represents a higher risk than a conventional bank loan, which is set after weeks of assessment. Higher risks attract higher returns for investors and therefore higher costs for borrowers.
- A short-term loan, which is on average six-months duration, means limited time for investors and the loan manager to earn a return on their at-risk capital and recover business origination and ongoing management costs. This pushes up borrowing costs.
- Each short-term loan is unique and requires a customised solution. This adds complexity to the loan assessment, establishment, collection and termination and drives costs upwards.
- If a borrower defaults on a short-term loan secured with a second mortgage, the claims of the short-term lender are second to those of the first mortgage holder. This can result in compromises and extended recovery times, which increase risks and costs.
- A proportion of any short-term loan book will inevitably experience some delays in payments and final settlements. A short-term lender will work closely with a borrower struggling to meet payment and exit obligations and do everything possible to ensure a satisfactory outcome. This increases risk and costs and therefore rates.
- There is no penalty to a borrower for an early settlement. So, it is in the borrower’s interest to expedite loan repayment and reduce cost.