Certain types of borrowers are big fans of hard money and bridge loans due to some of the benefits such loans offer. For example, some hard money lenders do not charge an early repayment penalty. That is pretty attractive to real estate investors and business owners. Still, borrowers might be subject to a guaranteed interest clause.
A guaranteed interest clause ensures that the lender earns a minimum amount of interest regardless of when a loan is paid off. Some lenders include such clauses in lieu of early repayment penalties. Others charge the penalties. Still others do not apply either option to their loans.
Actium Lending, a hard money and bridge loan provider out of Salt Lake City, UT, advises borrowers to always check contract language carefully. Actium does not charge early repayment penalties. But they know others do. Both early repayment penalties and guaranteed interest claims should be spelled out clearly in loan contract language.
The Guaranteed Interest Clause
Lenders utilizing the guaranteed interest clause do so in order to make sure they earn enough to make risking their money financially worthwhile. It is no different than a retailer setting prices that guarantee he meets his margin. If lenders don’t make enough money on each loan, lending becomes a business that is no longer worth the effort.
So even if a borrower were to repay in the second month, he would still be liable for the third month of interest. This may not seem like much in the grand scheme of things, but you need to keep in mind that hard money and bridge loans typically have terms from 6-24 months.
A 6-month term doesn’t give a lender a lot of opportunity to make its profit. By including a guaranteed interest clause in the contract, the lender will at least make enough to meet its margin. And meeting margins is crucial to staying in business.
The Early Repayment Penalty
The early repayment penalty has two purposes. In that sense, it’s very similar to the guaranteed interest clause. Its second purpose is to discourage early repayment. That’s why it is classified as a penalty.
At the same time, a lender doesn’t want to chase away potential customers by demanding that full interest be paid on a loan that is repaid early. Charging full interest would virtually guarantee that loans are not repaid early, tying up the lender’s cash for the longer
Neither One Is Required
Borrowers should know that neither the guaranteed interest clause nor early repayment penalty are required. Lenders can offer loans free of both. Some do, knowing that early repayment represents an opportunity to reinvest the money in another loan.
If you are planning on a hard money or bridge loan to meet your financial goals, be incredibly careful about contract language. Be sure you know what your contract says about guaranteed interest and repayment penalties. Do not be caught off guard should you decide to repay early.
The hard money industry has enough players that you should be able to find a lender with whose terms you can agree. Find the right lender and you could well be on your way to utilizing hard money to get where you want to go.
