can your buyer really afford a fixed rate loan?
The calls come in almost daily here in our shop, with the first question at times being: can you offer a fixed rate loan? Our response is always the same: can you afford it? What many clients don’t understand, and/or are not explained, is that fixed rates come at a cost.
By Steve Mariani
November 14, 2019
Actual costs are vary from lender to lender. Today, I will explain many of those costs and what we see happen to innocent buyers much of the time as they are led to believe fixed rates are a benefit.
Why fixed rates cost more
Most borrowers have only previously financed a house or car and have no specific knowledge of the SBA process, and even less of the actual rules surrounding the loan in which they are applying for. Here is where the gray area resides with many optional rules that can protect the assets of a buyer that are never brought to their attention. Let us start by explaining the differences between most fixed rate lenders and those writing adjustable rate loans. If the lender is offering a fixed rate, they usually plan to “portfolio” the loan, meaning they will keep that loan on their balance sheet for the entire term. These typically demand a much higher collateral requirement and can add many more internal bank rules to the already cumbersome SBA rules. One example is the personal real estate rule that says if the buyer’s personal property has less than 25% equity in it, then it does NOT have to be taken for collateral. That said, this does NOT prevent a lender from placing a lien on a property, even if it has no equity whatsoever. Lenders are always permitted to go above and beyond the SBA rules and add in many of their own. One of the largest SBA lenders in the country that offers fixed rate loans, and portfolios each one, has an internal policy that demands ALL properties owned by a borrower be taken for collateral with liens place on every one of them, no matter what amount of equity exists. Another internal policy of this lender requires all parties injecting any money toward the down payment to personally guaranty the entire loan amount. This again is an example of a fixed rate lender policy that is NOT required by the SBA. The list goes on and on, but the real concern is that borrowers are not aware of these “optional rules”, and usually just believe they are actual SBA rules.

Clients typically consider an SBA loan along the same lines as a mortgage or other debt product used to purchase a large asset, and are under the notion that all SBA lenders are created equal and the only concern should be interest rates. Nothing could be further from the truth, and these borrowers typically end up pledging more collateral then what’s required by the SBA and may also be exposing their spouse to unneeded loan exposure and guarantees. The SBA SOP’s (Standard Operating Procedures) outline the minimum requirements to secure the SBA’s guaranty for a specific loan request. The lender must meet all SOP guidelines and follow all SBA procedures to be able to rely on the SBA’s guaranty in the future. They are permitted to go above and beyond the guidelines at any time, and many fixed rate lenders do.

Where lenders go above and beyond
The three most common areas that we see lenders go above and beyond for the requirements are:

  • The loan term This can be shortened be any length term up to the SBA’s maximum
  • Collateral This can be all their owned real estate and cash accounts, even though the rule does not demand it
  • Required guarantors A lender can require anyone who they believe to be involved in the operation of the business, or just injecting money, to be full guarantors on the loan
  • The most concerning part of these practices from fixed rate lenders is that most borrowers are unaware that these lender rules could possibly be adjusted, left out of the loan, or in some other way used to protect a borrower from extra, unneeded risk moving forward. As an example, one of our recent clients owned eight rental properties and once we determined that only three were positioned where we had to place liens, we explained how we could protect his other five homes and allow him to use those as collateral to purchase additional rental properties in the future. He was explained to by a fixed rate lender that they would be presenting the same scenario with only the three properties taken, but just days before the closing he was then explained to that they needed to take more than just the three properties and possibly up to all eight. Being over six weeks into the transaction, there was no time to begin the process over and he was forced then to pledge more than what was originally discussed. Unfortunately, this scenario happens much more than you might expect and we witness it all over the country. We do not allow anything like that to happen at our firm as our relationship with our lenders is much too valuable to risk by using such practices.

When comparing fixed rate and variable rate loans, as long as the borrower understands the differences and weighs the risk and concerns, we do support the fixed rate option and recommend them for many clients, but the scenario must be in their best interest. Our company policy, and something we explain to every potential borrower, is that “We will ALWAYS provide the best available financing option for your transaction, whether or not that solution includes us”. If you are not directing your potential buyers to a conversation with Diamond Financial, what advice are they getting and from whom? Is that worth a fixed rate loan and can they truly afford the added rules and possible collateral additions?
Diamond Financial Services