Every loan, from a mortgage to a commercial loan, comes with basic parameters and guidelines that the bank must work within. For example, many mortgages are usually a 30-year loan instead of a 3-year loan. On the other hand, a commercial real estate loan might be between five or fewer years up to 20 years.
Many factors influence the terms of the loan, which creates the loan structure. Loan structure is important to both the bank and the borrower as it helps meet the borrower’s financial requirements while preventing the bank from taking on unnecessary risk.
It’s important to understand what the loan structure is influenced by to ensure you get a good loan structure for whatever type of loan.
How to Structure Your Loan
A good loan structure is vital to ensure you can pay off your loan in time and that the loan itself serves its intended purpose. A good loan structure is also important to the lender in order to ensure you won’t default on the loan.
Tailoring your loan structure to your needs and goals will allow you to avoid overspending and cause less stress. Structuring a loan is unique to each situation and individual, but there are some overarching loan features to be aware of before agreeing to a loan.
The type of loan – secured vs unsecured loans
The first step in getting a good loan structure is understanding what type of loan you want and need beyond just a mortgage or commercial loan. Most loans will fall into two categories: secured and unsecured loans.
Secured loans are loans that are secured with collateral. They are often more appealing to lenders because if you default on a secured loan, they have the right to use the collateral to pay off the loan. A mortgage loan is an example of a secure loan, as the house can be used as collateral. Secured loans are less of a risk to lenders, and they can come with lower interest rates and better terms than an unsecured loan.
Unsecured loans are repaid based on the promise of repayment. Lenders will take this into consideration, and there are often higher interest rates and stricter requirements to obtain these types of loans.
Interest rate – fixed vs variable
The interest rate is what the lender charges on top of the principal for lending the loan to the borrower. It can also be called the APR or annual percentage rate. The percentage of the interest rate depends on many factors:
- The amount borrowed
- The lender
- The type of loan
- The borrower’s credit
- Any collateral that is put down for the loan
Whatever interest rates you get will affect how much you pay over the lifespan of your loan.
There are two available types of interest rates: fixed or variable. Fixed interest rates are loans that carry the same interest rate throughout the loan; they do not change.
Variable loans, on the other hand, will change over time. They often start lower than a fixed rate at the beginning of the loan but can be adjusted from time to time based on the economy. While variable interests are often lower than fixed interest rates, your payment amount will change periodically, and it’s important to consider that for your loan structure.
Repayment – Lump sum vs installment loans
Repayment means paying back the loan, and there are two main ways to make this: installment plans or a lump sum payment. If you have a mortgage loan, you are usually going to do an installment plan, which means you borrow the money from the lender and pay it back in agreed-upon installments. These installments will include the principal, interest rate, and any additional fees.
If your loan is structured with a lump sum payment, you must pay the loan in a single payment, including accrued interest. This is at a later agreed-upon date. Smaller loans, such as personal loans, can be structured with a lump sum payment, but factors will influence it.
Most loans can be paid off early in full, but some lenders will charge an early repayment fee that will be laid out in the loan terms.
Other Factors That Affect Loan Structure
A lot of research and consideration goes into deciding a loan structure. While the type of loan and the interest rate are among the most important, many other factors influence the loan structure you receive. Some factors can be controlled, like the principal amount, while others, such as borrower’s risk, are more out of your control, and it will be up to the lender to assess your risk.
Loan Term – The loan term refers to the terms and conditions of a loan. This can include how long the borrower has to pay off the loan, associated fees, and interest rate. Before signing a loan, it will detail what is expected from the borrower and lender. If you disagree with the loan term, you can reject the loan or work with your lender to see if you can adjust the terms.
Principal or Loan Amount – The loan amount or principal is how much the loan is for. This is one of the biggest factors of loan structure. The principal does not include interest; the interest is a separate amount that will be added to the payment.
When looking for the right loan structure for you, loans with larger principals tend to have longer terms and different interest rates compared to smaller loans.
Collateral – The loan structure can shift depending on if the borrower puts up any collateral, such as personal assets. Collateral helps to lower the risk of a borrower from a bank’s perspective, which may lower the interest rate.
Risk of the Borrower – How much of a risk a borrower is determines much of the loan structure. If a borrower has good credit, collateral, and a large down payment, there is less of a risk that the loan will default. With less risk, you are able to get a better loan structure.
What is a Good Loan Structure?
A good loan structure is beneficial to both the borrower and the lender as they help save time and money for both parties. For borrowers, a good loan structure can increase the effectiveness of your loans, protect your assets, and even make restructuring your loans in the future easier. When deciding on which loan to go with or speaking to your lender about a current loan application, consider some of the following questions in order to get the best loan structure for you:
- What is the interest rate?
- Is the loan secured or unsecured?
- How many months do you have to pay back the loan?
- How are the payments set up – are they including the interest, or are they interest only?
- Do you have any financial reporting, and how often?
With all these factors in mind, a good loan structure will ultimately be the best option so that the lender is able to work with the borrower to achieve mutual benefits and reduce the risk of the loan defaulting.
Benefits of a Good Loan Structure
A well-structured loan has many benefits both to the borrower and the lender; the most important, of course, is that it meets the needs of the lender and the borrower. The borrower will be able to gain access to the cash flow they need while the lender will be assured their money will be paid back in time.
The right loan structure can also help protect the lender from losing money, protect a lender’s assets, and even provide the right tax benefits. They can price a loan within reason that will still allow them to gain profit.
For a borrower, a good loan structure often means getting the best loan possible for their situation. This could mean lower interest rates, a larger amount, or a better loan term, allowing them to save money.
Getting a Well Structured Loan
Every borrower has different wants and needs when finding the right loan structure. For example, you might need a small business loan with excellent interest rates that you can pay off in one lump sum, but you have a risky credit history. To achieve your goals, your lender should work with you to find a loan structure that works for both of you.
Understanding what goes into a loan structure will allow you to be more informative when making large financial decisions. It’s easy to agree to the first loan you are approved for, but take a closer look to ensure that the structure will work for you and won’t cost you more money than needed.
If you have any questions about loan structure or are interested in applying for a loan, contact one of our specialists for help.
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Information contained in this blog is for educational and informational purposes only. Nothing contained in this blog should be construed as legal or tax advice. An attorney or tax advisor should be consulted for advice on specific issues.