1 00:00:00,970 --> 00:00:05,440 I needed to find some words used in lending before you will be able to understand details about the 2 00:00:05,440 --> 00:00:06,790 types of business loans. 3 00:00:06,820 --> 00:00:08,690 We'll start with principal and interest. 4 00:00:08,860 --> 00:00:12,400 A simple definition for principal is that it's the amount of the loan. 5 00:00:12,430 --> 00:00:15,790 Sometimes people call it the balance or outstanding balance of the loan. 6 00:00:15,790 --> 00:00:20,260 This definition works well for real estate loan where you get a large amount of principal at the beginning 7 00:00:20,260 --> 00:00:24,640 of a loan and you make periodic payments to reduce that principal over the life of the loan. 8 00:00:24,640 --> 00:00:29,380 Lines of credit have a commitment amount that's the maximum amount that can be borrowed at any time. 9 00:00:29,440 --> 00:00:33,170 Let's say you have a line of credit with a commitment amount of one hundred thousand dollars. 10 00:00:33,190 --> 00:00:38,320 You don't take any advances on this line for the first month in month 2 you transfer ten thousand dollars 11 00:00:38,320 --> 00:00:40,270 from the line to your checking account. 12 00:00:40,270 --> 00:00:43,720 This is called an advance or a draw on the line at this point. 13 00:00:43,720 --> 00:00:47,450 The commitment amount is still and will always be one hundred thousand dollars. 14 00:00:47,650 --> 00:00:49,780 The principal balance is ten thousand dollars. 15 00:00:49,780 --> 00:00:54,550 The difference between these two of ninety thousand dollars is your available balance. 16 00:00:54,550 --> 00:00:56,790 The principal balance is listed on the balance sheet. 17 00:00:56,860 --> 00:01:01,340 The commitment amount and available balance would be disclosed in the notes to the financials. 18 00:01:01,340 --> 00:01:03,910 I talk more about disclosures later in this course though. 19 00:01:03,940 --> 00:01:07,870 OK now let's talk about cash outflows and expenses. 20 00:01:07,870 --> 00:01:10,020 Interest is a part of the cost of the loan. 21 00:01:10,030 --> 00:01:13,780 The other parts are fees and penalties and they'll be discussed later. 22 00:01:13,870 --> 00:01:18,720 The interest payment amount of a loan is calculated as the interest rate times the principle of a loan. 23 00:01:18,730 --> 00:01:24,040 Loan payments may be interest only principle only or a combination of both construction loans are an 24 00:01:24,040 --> 00:01:26,210 example of interest only loans. 25 00:01:26,290 --> 00:01:30,040 The borrower only pays interest and not principal during construction. 26 00:01:30,130 --> 00:01:34,990 Once construction is completed it's converted to or paid off by a regular commercial real estate term 27 00:01:34,990 --> 00:01:35,230 loan. 28 00:01:35,860 --> 00:01:40,320 An example of both interest only payments and principal only payments are lines of credit. 29 00:01:40,900 --> 00:01:44,940 Let's continue with our line example from the previous slide in month 3. 30 00:01:44,950 --> 00:01:48,870 You would own interest only payment for the interest accrued during month 2. 31 00:01:48,880 --> 00:01:53,500 This is an interest only payment if you decided to pay down the line to zero in month 3. 32 00:01:53,500 --> 00:01:59,710 This would be a principal only payment payments for term loans on equipment or real estate or a combination 33 00:01:59,710 --> 00:02:01,420 of interest and principal. 34 00:02:01,450 --> 00:02:08,100 Bankers often call these types of payments PMI payments for principal and interest payments the rate 35 00:02:08,100 --> 00:02:13,760 on a floating or variable rate loan is calculated as the index rate plus or minus a spread. 36 00:02:13,830 --> 00:02:19,430 Let's look in more detail at each of those two components the index is usually a rate that's widely 37 00:02:19,430 --> 00:02:21,140 used in financial markets. 38 00:02:21,140 --> 00:02:26,080 Examples include the prime rate Treasury rates or borrowing rates from a Federal Home Loan make or FHA 39 00:02:26,090 --> 00:02:32,030 I'll be for short FHA LP as are special banks whose only customers are banks credit unions or insurance 40 00:02:32,030 --> 00:02:33,200 companies. 41 00:02:33,200 --> 00:02:37,470 The FHA Shelby's provide funding for those other financial institutions. 42 00:02:37,590 --> 00:02:42,170 The primary may be the bank's primary or the Wall Street prime rate which is published in The Wall Street 43 00:02:42,170 --> 00:02:47,640 Journal the spread is the amount that's added to the index rate to arrive at the total interest rate 44 00:02:47,640 --> 00:02:49,060 you pay on your loan. 45 00:02:49,080 --> 00:02:53,880 For example if the prime rate is four point seventy five percent and you are charged a 2 percent spread 46 00:02:53,910 --> 00:02:57,600 then you pay a total interest rate of six point seventy five percent. 47 00:02:57,600 --> 00:03:01,520 The riskier you are as a borrower the higher the spread that's added to the index rate. 48 00:03:02,930 --> 00:03:08,000 Now let's talk about a little piece of the fine print and loan agreements that increases the rate borrowers 49 00:03:08,000 --> 00:03:09,120 pay. 50 00:03:09,140 --> 00:03:13,520 There are different ways that days can be counted or allocated when calculating how much interest you 51 00:03:13,520 --> 00:03:20,430 on each payment for the explanations and examples in the next couple slides will assume monthly payments. 52 00:03:20,450 --> 00:03:25,330 The method for calculating the days is called the day count basis or the day count method. 53 00:03:25,370 --> 00:03:30,290 Actual actual is calculated as the actual number of days in the month divided by the actual days in 54 00:03:30,290 --> 00:03:36,680 the year actual 360 is calculated as the actual number of days in the month divided by three hundred 55 00:03:36,680 --> 00:03:38,000 and sixty. 56 00:03:38,030 --> 00:03:41,490 The actual 360 basis is common in business loans. 57 00:03:41,660 --> 00:03:46,600 The interest paid on an actual 360 basis is higher than an actual actual basis. 58 00:03:46,670 --> 00:03:54,800 The denominator of 360 in an actual 360 is higher than the 365 or 366 used in actual actual hold tight. 59 00:03:54,800 --> 00:03:57,910 If I've lost you I'm going to show you an example here. 60 00:03:58,070 --> 00:04:00,770 I know CPA or show me the numbers types. 61 00:04:00,770 --> 00:04:02,480 So here's an example. 62 00:04:02,480 --> 00:04:07,340 Let's assume you have a loan with a million dollar principal balance bearing 7 percent interest. 63 00:04:07,370 --> 00:04:14,030 Let's calculate your January interest payment using the actual actual an actual 360 methods using actual 64 00:04:14,030 --> 00:04:19,170 actual you would multiply the million dollars times point 0 7 for the 7 percent interest. 65 00:04:19,190 --> 00:04:24,880 Times the 31 days in January divided by the three hundred and sixty five days in a normal year. 66 00:04:25,070 --> 00:04:29,840 Your January interest payment is roughly five thousand nine hundred forty five dollars. 67 00:04:29,840 --> 00:04:36,980 Now using actual 360 you multiply the million dollars times Point zero seven times the 31 days in January 68 00:04:37,040 --> 00:04:43,440 divided by 360 your January interest payment is now roughly six thousand twenty eight dollars. 69 00:04:43,550 --> 00:04:48,620 If you summed up all the actual actual payments for the year total interest costs are seventy thousand 70 00:04:48,620 --> 00:04:53,190 dollars which is what you would expect if you multiplied a million dollars times 7 percent interest. 71 00:04:53,390 --> 00:04:59,210 However you would pay a total of seventy thousand nine hundred seventy two dollars using an actual 360 72 00:04:59,210 --> 00:04:59,990 basis. 73 00:05:00,140 --> 00:05:04,730 If you divided that seventy thousand nine hundred and seventy two dollars by the million dollars principal 74 00:05:05,100 --> 00:05:07,940 it would equal around seven point 1 0 percent. 75 00:05:07,940 --> 00:05:12,890 In other words the lender has increased their interest rate by point 1 0 percent by using the actual 76 00:05:12,890 --> 00:05:15,370 360 day count basis. 77 00:05:15,410 --> 00:05:20,550 I'm pointing this out so you can make apples to apples comparisons of loan rates from different lenders. 78 00:05:20,600 --> 00:05:25,160 They may both say they are charging you 7 percent but if they use two different discount bases then 79 00:05:25,160 --> 00:05:27,570 you will pay less with one of those lenders. 80 00:05:27,590 --> 00:05:29,000 It's a little thing to pay attention to.