What to look for when comparing lenders when sourcing bridging and development finance. Richard Whitehouse writes for NACFB's February 2020 Commercial Broker magazine.

1. Special Feature
When is an
apple not
an apple?
W
hen I was setting myself up at university and looking
to buy a printer the advice my father gave me was
to focus on the price of the ink cartridge, not the
printer itself. He was of course telling me to consider the total cost
of ownership rather than the headline cost of the printer alone.
Essentially getting me to compare apples with apples and consider
the true cost.
Little did he or I know that his advice would be transferable into
the world of bridging and development finance. “Give me your best
interest rate quote”, is a common request and I am consistently
surprised by how much importance borrowers place on this one
metric. Especially when there are several cost lines to term sheets
and often different ways of calculating them.
How do borrowers give themselves a chance to compare apples
with apples when lenders are not converting their costs to an Annual
Percentage Rate (APR)? What should they and their advisor be
looking out for?
Let’s start with the primary focus of that attention, the interest rate.
Why lender interest rates can
sometimes be misleading
Richard Whitehouse
Head of Business Development
The Sancus Group

2. If the headline cost is the rate, then is 9.5% per annum really
cheaper than 10% per annum? The answer comes down to whether
the lender is charging interest on a simple basis or on a compound
basis? We’ll call the simple interest lender “White Bank” and the
compound lender “Grey Bank”.
On a £1 million bridging loan over 18 months it would be cheaper
to take the 10% deal from White Bank than the 9.5% from Grey
Bank, assuming the Grey Bank compounds on a monthly basis.
Some lenders will compound on a daily basis (“Black Bank”), in
that scenario the simple interest lender can be 0.75% more on their
headline rate compared to Black Bank and still cost less in total.
0.75% is a significant difference on the headline rates –
see example one.
Example 1
NACFB | 37
• Is the lender using a fixed rate or a floating rate? If it’s a floating
rate what base rate is the lender using? LIBOR is not the same
as Bank of England Base Rate, which is also different to the
Bank’s own base rate. Always find out the basis and the base
rate number.
• When the lender presents their price at X% plus base, always
re-write the number to the total interest rate. Assuming base
rate at 0.75% then you might read 8.75% plus base rate. Grey
Bank looks great on their rate as the inevitable focus is on the
printed number, the reality is that it is 9.5% and that’s before we
go back to the issue of compounding.
• Does the lender apply a floor rate to the base rate they are
using? The floor rate means that irrespective of the base rate
reducing, the lenders base rate will never fall below their floor
number. For example, a floor rate of 1% means Grey Bank will
always add 1% to their margin even if base rate is at 0.25%. Grey
Bank could now state their interest rate as 8.5% plus base rate
and be more expensive than the 10% option from White Bank.
What else might the Grey Bank be doing to boost their income?
The starting point is the ‘in’ fees and this becomes especially
relevant where interest is rolled up. Does the lender calculate
the arrangement fee on the loan amount or do they include the
expected interest amount in the loan and charge the arrangement
fee on the higher number? For a large loan and particularly over a
longer term the differences can be painful.
Even in the example of a £1 million bridging loan, and assuming a
2% arrangement fee, White Bank will be charging £20,000. Grey Bank
will be charging just over £23,000, see example one.
When the exit fee is applied on a similar basis, assuming a 1% fee
rate, then White Bank is going to charge £10,000 and Grey Bank will
charge just over £11,500, see example one.
It’s also important to keep an eye out for the following approaches to
interest charging:
White Bank Grey Bank Black Bank
Loan £1m £1m £1m
Term 18 months 18 months 18 months
Arrangement
Fee
2% £20,000 2% £23,000 2% £23,000
Interest Bill 10% £150,000
8.75%
Plus Base £152,500
8.75%
Plus Base £148,960
9.50% 1%
Exit Fee 1% £10,000 1% £11,500 1% £11,500
Total cost £180,000 £187,000 £183,460
Cost of
Capital
18.0% 18.7% 18.3%
% Difference n/a 3.90% 2.00%

3. 38 | NACFB
C
M
Y
CM
MY
CY
CMY
K
Grey Bank are over 10% more expensive than White Bank despite the
apparently attractive interest rate.
One more practice that might be employed is the discounted interest
rate. If the Black Bank compounds daily, then the discounted interest
rate is used by “Blackhole Bank”. This approach to interest rates
shows the borrower a headline rate of say 9% per annum which is
a discount to the contractual rate of 24% per annum. The discount
applies for the six or 12 months and then the loan reverts to its
standard rate 24% per annum, 9% is the number in large letters but
the expectation on the part of Blackhole Bank is that you cannot
achieve an exit to the loan in the discount period and they will
benefit from a long period of standard rate interest. Blackhole Bank
will even try to ensure the discounted loan term is too short to force
the move to standard rate.
Generally smaller fee items, but also worth checking, are the
professional costs levied by the lender. For example, I have seen
cases where the lender charges the Monitoring Surveyor (MS) fees
to the loan account and settles with the MS directly. Those charges
were more than twice what we would normally expect to pay an MS
for a similar project.
To ensure that apples are indeed being compared with apples the
borrower and their advisors should ignore the headline interest rate
and work out the total cash cost of the options in front of them. That
will give a clearer picture of the price for working with each lender.
Given that cash advances will often vary too, then a proxy for APR
would be to take the total cash cost of the facility and divide it by
the money made available to the borrower (i.e. not including the
interest or fees). Expressed as a percentage the borrower will have
a better figure for comparison to focus on rather than the headline
interest rate.
Borrower and advisor can then start to think about the softer
but probably more important elements of selecting a lender from
certainty of funding to ease of use. Pricing is only one component of
the choice and I would argue it’s not the same as value. Nevertheless,
I would advocate pricing is an important metric to have a clear
understanding of.
So, in short, always focus on the price of the ink.
All in all, that’s £4,500 more in fees or a 15% higher cost, despite the
headline percentage rates appearing to be exactly the same.
Recently, I have seen examples on development loans of
lenders charging their exit fees as a percentage of GDV. If that
isn’t understood properly at the outset, the client will be in for a
rude surprise on redemption. The particular example required a
£1,000,000 loan on day 1 and a further £1,000,000 to develop the
property which had a GDV of £3,500,000. The headline rate of 8.75%
plus base rate seemed attractive, but below was the real breakdown
for the borrower.
Example 2
“Give me your best interest
rate quote”, is a common
request and I am consistently
surprised by how much
importance borrowers place
on this one metric
“
White Bank Grey Bank
Loan £2m* Loan £2m*
GDV £3.5m GDV £3.5m
Term 18 months Term 18 months
Arrangement
Fee
2% £40,000
Arrangement
Fee
2% £44,240
Interest Bill 10% £230,000 Interest Bill
8.75%
Plus Base
£232,000
Exit Fee 1% £20,000 Exit Fee 1.3% £45,500
Total Cost £290,000 Total Cost £321,740
Cost of Capital 15% Cost of Capital 16%
% Difference n/a % Difference +10.9%
*Note - Construction advances are assumed to be equally drawn over the term of the loan