In a previous post, I mentioned that a loan and a line of credit serve the same purpose. While that may be true in a broad sense, they actually can be quite different. Hence, the different names. The bank will look at both types of credit the same way, evaluating the amount of credit requested against the amount and type of collateral offered. The customer, however, only cares about one thing, which option is cheaper.
Credit, as we all know, is money the bank gives you as a short term gift, so to speak. A loan, then, can be viewed as a lump-sum gift. We are generally familiar with loans when buying cars or homes. These loans are for relatively long amounts of time where the borrower pays back the credit a little at a time, either monthly or quarterly, until the end of the loan term when — poof — the amount borrowed has all been paid back.
A bridge loan is different from the above loan. The biggest difference between the two types is that a bridge loan is generally for a shorter period and is paid back in one payment, full, at the end of the loan’s term. These type of loans are usually against an expected income/donation and function similarly to lines of credit. A bridge loan is advantageous when the customer needs all of his credit limit right away and is expecting to pay it back in one shot.
Line of Credit
A line of credit is not a gift at all, but more of an understanding between the client and the bank. The bank will allow the account to go into a minus up to a pre-agreed amount. This type of credit is useful when the length of time that an organization will be in debt is known but the amount is not known. During this credit period, depending on incomes received and daily activities, the actual amount of credit used could vary. Some days the account is in minus and some days not. Some days the entire line is used and other days only a portion. The advantage of the line of credit is its flexibility; the customer is only charged interest for what is used. Like the bridge loan, there are no interim payments for the line of credit, just the requirement to repay the credit in full when the period ends. Assuming an organization knows from the beginning that it will be using all of its line of credit for the entire length of the debt period, a bridge loan is going to be a better option.
Show Me the Money
Built into the flexibility of a line of credit is a higher interest rate than that of a loan. Over the term of the line of credit, because the full amount is rarely used, this option incurs less interest fees than a loan — despite its higher rate of interest. Loans have a lower rate of interest but you need to borrow the entire amount from the bank. If in the end you didn’t need the loan, tough luck and pay up.
Both options will have two fees attached to them. First, is the interest on the credit used. Call it a gift or an understanding, anytime you use money that you technically don’t have, you’re going to pay for it. Lines of credit will be based on Prime, which is based on the Bank of Israel’s interest rate, thus, subject to change. Loans may also be based on Prime or fixed. Second, both options will also have a one-time handling fee, as well. Lines of credit might call these fees “credit allocation” (amalat haktza’at ashrei) while loans might refer to them as “preparation” (hachanat tefasim) or “folder opening” (petichat tik) fees. These one-timers are generally based on a percentage of the credit being taken and may be dependant on the lenght of the credit, as well.
Be aware that business customers may get quoted higher rates than individual customers, as stipulated by the new Fee Law that went into effect July 2008. Unfortunately, any nonprofit that has a yearly cash flow of over one million NIS is considered a business as far as the Bank of Israel is concerned.
Questions to Ask your Banker
- How much is the interest?
- Is the interest variable (based on Prime) or fixed?
- How much is the handling fee?
- For loans, can you pay them back early? Is there a penalty involved?
- For lines of credit, what fees can I expect if none of the credit is used? Are there any penalties?
- Are there any additional fees?
- What is the bank using as collateral?
- What promises/commitments have I made to the bank?
While I have provided a list of the basics, please, please, please, remember that each bank is slightly different. Ask your banker any and all questions you think are relevant, “The only stupid question is the one not asked.”
Tizku LeMitzvot [May you continue to merit doing good deeds],