Borrowing Basics and Key Terms
Similar to education, the world of finance has a language of its own. Below are basic terms that a potential borrower should understand and be able to discuss before approaching a lender.
- Fixed Rates: Interest that remains at the same rate for the entire life of the loan
- Variable Rates: Interest that changes rate based on the changes in an agreed upon index
- Loan Term: Loan terms will vary from very short (construction) to long (permanent). The "permanent" loan term offered to a charter school that is a first time borrower will likely be in the 5 - 10 year range, meaning that after the 5 - 10 term expires, the school must either pay off the remaining debt or refinance the loan. When discussing the loan term, ask if there is a prepayment penalty. If so, this will decrease your flexibility to refinance the loan at a time when it becomes most advantageous for you to do so.
- Amortization Period: This is the period of time that you pay off your debt. If you are making equal payments each month to pay off your loan, an amortization period of 20 years will result in higher monthly payments than a period of 30 years. Charter school operators are likely to see amortization in the 20 - 30 year range. The amortization period may ex¬tend beyond the length of the loan term. If this is the case, you will be expected to pay your remaining loan balance at the end of the loan term.
- Collateral: Collateral are the assets used to secure the debt, and the strength of your collateral will affect the rate you receive. Permanent loans will be less expensive because the property secures the loan. With leasehold loans, in the event of a default, the bank can only try to lease out the space again to recover costs. As charter schools often do not have large assets, some schools have successfully encouraged wealthy board members or philanthropists to pledge money to a fund to be used as collateral. This type of "donation" may save the school thou¬sands and will cost the donor nothing if the school makes all of its payments. Please note, however, that the Association recommends that any charter operator or board member take a very strong look at the risks and their own financial situation before using personal assets such as a home to secure a charter school loan.
Types of Loans
- Construction loans: Short term loans that pay for the construction or renovation of a property owned by the school. The actual cost of acquiring the property may be included in the construction loan as well. These loans are typically for a maximum of 18 months and often only interest payments need to be made during construction. The approval of a construction loan will likely be contingent on an identified permanent or take-out loan.
- Permanent loans: Available for the purchase of a property or to take out the construction loan. Unlike construction loans, usually the interest as well as a portion of the principal is paid monthly. Charter schools often do not receive loans with term lengths similar to those used for home mortgages. Instead, the length of a permanent loan for charter schools is in the neighborhood of 7 - 10 years, requiring borrowers to pay the remaining principal or refinance with another (more) permanent loan at the end of the loan term.
- Leasehold improvement loans: Provide financing to renovate facilities that the borrower leases. The loan amounts that are approved for leasehold improvements tend to be much lower than permanent or construction loans due to the lack of collateral as the borrower does not own the property. To mitigate some of this risk, the lender will often require an assignment of the lease. However, even with this assignment, some lenders are reticent to make leasehold improvement loans. One word of advice to make your leased property more attractive is to get a long term lease, as the term of your loan will likely not exceed the lease length.
Fees: With each round of financing, expect to pay several fees. It is important to ask from the outset which fees will be charged:
- Application Fee: Ranging from $100 - 1,000, this fee is submitted with the application. If the loan is approved, the application fee should be credited towards the origination fee.
- Origination Fee: This fee, usually in the range of one to two percent of the loan amount, is due when the loan closes. For example, an origination fee of 1.5 percent on a $2,000,000 loan is $30,000. The fee is often withheld by the lender from the first loan disbursement. The purpose of this fee is to cover the costs for the lender associated with underwriting the loan.
- Legal Fees: The borrower typically pays for the legal costs of both the borrower and the lender. These costs can be substantial. While pro bono services may be available, John Piscal, CFO of the Inner City Education Foundation, cautions against utilizing pro bono services: "be upfront with any pro bono counsel about how much work this really is so that they do not lose interest in the project over time or damage your relationship [with your lender]."
Interest: Investopedia.com defines interest as "the charge for the privilege of borrowing money." A less sunny description is that interest is simply what you pay and what the lenders earn. Using $2,000,000 as an example, an eight percent annual interest rate means that the borrower would pay $16,000 for the privilege to borrow money each year. An interest rate can be fixed or variable. Fixed rates have the benefit of predictability, while variable rates may increase or decrease costs throughout the loan term.
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