How To Protect Your Commercial Loan In A Downward Market
I had a question from a prospective client recently who asked, “Why do commercial banks usually only offer 3 year rolling terms as opposed to a 30-year term like a residential home loan?”
Part of the reason is due to interest rates and providing the bank with a provision to make adjustments to the BBSW. However, the main reason is to allow the bank to review both the value of the asset they hold security against in addition to the borrower they’ve lent to.
Both these factors can have significant impacts on a customer, which I will explore briefly and provide you with an alternative way to structure your loan if you believe there would be a benefit.
Looking back at what happened to commercial property markets during the GFC serves a very good reminder of the risks associated with short-term loan contracts. At the time, commercial property markers were down between 20-40%.
The RBA noted that “impaired commercial property exposures accounted for around 30 per cent of Australian banks’ non-performing domestic assets at the time.”
Why was this the case? Well, what happened during this period was as loan agreements were up for renewal, banks re-ordered valuations. When these valuations came in low the bank adjusted their LVRs so customers had to either come up with a lump sum of money to reduce the loan or were forced to sell.
When banks provide loan terms, a common method of mitigating their risk is to also have income assessment measures of the borrower. This creates risk in that if the borrower’s income has dipped at the time of review, the lender has the ability to either increase their interest rate or lower their LVR.
An Alternative Method
Smaller commercial lenders understand the issues associated with the way major banks structure their commercial loan agreements. In response, there are a few lenders who have niched themselves to offer loan terms very similar in structure to that of a typical residential loan. That is, with no requirement to revalue the security and no requirement to provide updated financials.
When considering your next commercial loan, examine your own situation and whether a short-loan term loan agreement could have a negative impact on you. Remember there are alternative methods available that can potentially carry far less risk.