It’s important to gain an understanding of the lender’s familiarity with the nuances of underwriting loans to nonprofits, which not all lenders have. Specifically, it’s crucial that the lender understands and is comfortable with the organization’s business model and how its revenue cycle is impacted by government contracts, grant disbursements, and fundraising. Beyond the underwriting process, familiarity with these nuances is also essential to managing the relationship with the borrower after the loan is closed.
Resources nonprofit leaders can use
IFF has helped more than 1,200 nonprofits create mission-driven facilities optimized for their needs, and we regularly share learnings we’ve accrued along the way. To access past content designed to provide nonprofit leaders with foundational knowledge needed to successfully complete facility projects, click here.
For nonprofits with consistent revenue and a track record of financial stability, debt can be a powerful tool to complete transformational facilities projects, providing a means to expand capacity and impact more quickly than they could by raising funds strictly through a capital campaign. Leveraging debt can also provide an organization with the financial flexibility to meet pressing needs by spreading out the cost of a capital project over the term of the loan.
As we’ve shared in the past, it’s imperative for nonprofit leaders to fully interrogate their organization’s financing options before making a decision about what loan is the right fit, as a variety of factors beyond interest rates influence the cost and flexibility of borrowing money. Gaining an understanding of a potential lender’s experience working with nonprofits, the process they follow to underwrite a loan, their willingness to be flexible after the loan closes, and other factors are critical to evaluating if borrowing money is an effective strategy to achieve the organization’s facility goals.
With that in mind, we’ve compiled a list of 12 questions nonprofits can ask potential lenders to better evaluate if a loan will be a good fit for the organization’s financing needs.
Questions for Potential Lenders
What experience do you have lending to nonprofits?
What is the application process, and are specific documents needed to apply (e.g., audits, monthly financials, board list, grant itemization)?
The application process for a loan requires the borrower to provide a variety of materials to the lender that can be used to determine the borrower’s financial position and ability to repay the loan. Lenders follow unique internal processes to evaluate loan applications, and this can impact how quickly – or not – a loan is approved and closed. Nonprofits can get a head start on compiling this documentation to ensure that the loan is approved and closed more quickly by asking potential lenders what they will require to provide financing.
Most lenders require an appraisal to determine the estimated value of a property before providing a loan tied to real estate. This can present a challenge to nonprofits located in under-resourced communities where property values were driven down for decades by redlining. Though redlining was outlawed in 1968, the impact of the practice continues to affect property values today and makes it more difficult and expensive for most nonprofits to access affordable debt that covers the true cost of the project because of where the facility is located. This is why IFF has provided loans without appraisals for our entire 36-year history. As a result, it’s crucial to know whether a potential lender will require an appraisal and how that will influence the size of the loan their institution is willing to provide.
It’s also a good idea to know what additional third-party documentation the lender will require before closing a loan, such as a survey or zoning approval, as these represent additional hurdles the organization will need to navigate before being able to proceed with its project.
Are there any lending terms that are specific to nonprofits that would be favorable to the organization (e.g., flexible repayment options)?
Some financial institutions may offer different terms to nonprofit and for-profit borrowers for facility loans, and it’s worthwhile to ask whether terms can be adjusted to better meet the organization’s financing needs.
What is your current interest rate, and how often does it change?
The interest rate is one factor that determines the cost of borrowing money, and it is usually communicated as a percentage (i.e., the interest rate). This is what is owed to the lender in addition to the principal. Interest rates vary from one lender to the next and fluctuate with market conditions, so it’s important for nonprofits to explore options with multiple lenders and to understand whether the interest rate being quoted is likely to change before the organization is ready to proceed with the lender it chooses.
It’s also important to understand that the interest rate is only one component of loan “cost.” Fees, collateral requirements, minimum equity, and other terms can factor greatly into the overall affordability/cost of a loan. Flexibility is also important, so stipulations like prepayment penalties and financial covenants should also be considered in conjunction with the interest rate offered for the loan.
Is there a prepayment penalty that would keep us from paying off the loan in advance of the term? If so, what is it and can it be negotiated?
Some lenders charge prepayment penalties to borrowers, and it’s important to know before taking on a loan whether it can be repaid early without incurring additional costs. For a nonprofit, an unexpected contribution could provide the organization with the ability to pay off a loan earlier than anticipated, enabling the organization to reduce the amount of interest paid on the loan.
Do you require the applicant to move certain account(s) to your bank if pursuing a loan?
Some lenders may require the organization to have an existing relationship via a checking and/or savings account with the institution before initiating a lending relationship. This is not a requirement in most cases but may still influence the loan terms offered to the organization. Getting clarity about this while evaluating loan options is a good idea, as it can impact the organization’s current accounts/relationships.
Is there a percentage or minimum equity contribution you like to see?
If the loan amount the lender is willing to provide is tied to an appraised value of a property (i.e., loan-to-value ratio), the loan may only be obtainable if the nonprofit borrower is able to bring significant cash to the table. Many nonprofits don’t have the cash on hand required to do so, resulting in a need to raise dollars – which takes time – or reallocate dollars – which reduces impact – to obtain the loan. For organizations that do have available cash or liquidity, understanding the cost of tying up significant cash in the project instead of using it for staffing, programs, or reserves should be part of the evaluation process.
What is your loan term?
The loan term is the period of time during which the borrower agrees to repay a loan and, with fully amortizing loans, it matches the amortization schedule. When the loan term is less than the amortization term, there is a balloon payment at maturity.
If an organization secures a loan with a term of five years and needs to refinance a balloon payment at maturity, it may have to absorb the same costs it did to secure the original loan (e.g., legal fees, origination fees). There are potential cost savings and added peace of mind that come with longer-term loans. Once the original loan is secured, the organization can know with certainty that it will not have to go through the same process again in several years, and it also mitigates the risk that the original lender will not agree to refinance the balance.
What is the amortization period for your loan?
Amortization is spreading out the repayment of a loan over a set period of time, with the borrower generally paying the same amount each month until the loan is fully repaid. A longer amortization schedule reduces the amount of money the borrower is required to pay each month, but it also means the total amount of interest paid over the course of the loan term is greater. There’s not a right or wrong answer in terms of what amortization schedule is best for an organization without detailed knowledge of its specific financial circumstances, but understanding the “cost” of paying more quickly vs. over a longer period of time, and what amortization schedules potential lenders are offering, is important in evaluating what option best meets organizational needs.
What fees do you charge for borrowing?
Fees, to some extent, are an unavoidable business expense of borrowing. The drafting and negotiating of loan documents, for example, results in legal fees. These fees can vary widely, however, and borrowers should ask for an estimate of legal fees early in the process. Closing fees are another common cost for borrowing, which may include title fees and UCC searches to ensure the collateral is not already encumbered.
Other common fees include application fees and origination fees, generally charged to cover the costs of evaluating and extending the loan. For example, IFF charges a one percent origination fee and allows borrowers to finance that cost and roll it into the loan amount. This means that borrowers don’t have to provide cash up front to cover the origination fee before receiving a loan.
Are there financial covenants associated with the loan?
Financial covenants are obligations the borrower agrees to meet during the loan term. They can include a variety of financial ratios that measure liquidity, leverage, or debt service coverage and are regularly measured to ensure compliance. Even if loan payments are being made as agreed, if these other “promises” are not met, the loan is in technical default.
While the lender can formally waive the default, it requires time and (often unwanted) attention. If the lender doesn’t formally waive the covenant violation, it shows up on the organization’s audit – creating a permanent record of the default about which donors and funders may draw conclusions. Covenant violations can also trigger a default interest rate that’s higher than what the organization was paying previously. And if the lender is looking to exit the relationship entirely, the default gives them the opportunity to do so.
Given the legal obligations of taking on a loan, it is critical to understand the full scope of commitments being made – and potential consequences of not meeting them – before taking on a loan.
How do we get started?
This question is fairly self-explanatory. Before the organization reaches a decision about taking out a loan, it’s useful to know what the next steps will be to move forward with the underwriting process and, ultimately, to get to the loan closing.
To discuss financing options for a nonprofit facilities project, please contact our Capital Solutions team.