Types of Loans for Charities

This article provides a summary of the main types of loan finance available including term loans, leasing, bridging, working capital loan, overdraft nd factoring/discounting.

Term Loans

A term loan is a particular amount of money lent for a particular term which must be paid back according to an agreed schedule. Lenders usually try to match the term of the loan to the life of the benefit it produces. For example, loans to purchase buildings are usually long-term, from ten to twenty-five years. The interest on term loans is usually variable, which means that is will go up and down as the banks raise and lower their interest rates. You can ask for fixed rate loans; however, fixed rates are not common for loans over five-year terms.

The lender will usually require the loan to be secured by an asset, such as a building or land. This means that as long as the loan remains, you share ownership of the asset and cannot sell it without the permission of the lender. If you are having problems repaying the loan, the lender will first try to reschedule the loan to set the payments at a level that you can manage. If this fails, they will sell the asset to raise the money to repay the debt.

A Senior Term Loan is the usual type of loan provided by the banks. This means that the ‘senior lender’ will be paid back before other lenders. A Subordinated Term Loan will only be repaid when the senior term loan is repaid. Because it is higher risk, banks may be unwilling to provide this type of loan. They tend to leave them to social finance lenders.

Example: North City Business Centre Ltd (NCBC) was formed in 1991 following a period of consultation with the community in lower North Dublin. The centre has become extremely successful and is now 100% occupied with a considerable waiting list for workspace. Given that the centre was now operating at full capacity with a waiting list of potential tenants, the Board of NCBC decided to expand the premises by constructing an additional 12,153 sq ft of hi-tech and service orientated workspace on site. The expansion would represent a third phase development of the centre. The funding required to construct the facility was secured from the International Fund for Ireland, NCBC's resources and a loan..

Leasing

Leasing or ‘hire purchase’ is used to finance equipment and fixed assets. You make a monthly payment for the use of the asset, but may never own it. Specialist leasing organisations or equipment sellers may be willing to finance the purchase of equipment such as photocopiers, IT equipment, etc.

Bridging Loan

A bridging loan is a short-term loan to help cover a cash shortfall due, for example, to late payment of grants or payment in arrears. The loans will usually be for a period of a year or less and will be "interest-only" with the principal repaid in a lump sum. It is rare for mainstream banks to offer bridging loans, as they have, over time, developed a distrust of funders.

Working Capital Loan

A working capital loan is a revolving loan, where any amount up to an agreed maximum can be drawn down and repaid repeatedly during the loan term. It funds the operations of the organisation and is usually agreed for a year at a time.

Example: XYZ organisation works with deprived rural communities to strengthen their local economies through IT and networking. It is a company limited by guarantee and a charity. It needed working capital finance to deal with the uncertainty about the amount and timing of future contracts. It also wanted to develop a credit history to access mainstream finance in the future. The funding package it secured was a Working Capital loan of €75,000 over nine months with a 6% interest rate and 1% arrangement fee, Interest only, with flexible lump sum repayments dependent on timing of cash flow. The finance institution also required that the organisation should not borrow elsewhere during the loan and asked for written confirmation of a major grant and a copy of its contract with a government department.

Overdraft

An overdraft is a borrowing limit authorised by the organisation's bank. The bank agrees to allow the organisation to spend over its current account balance up to an agreed limit. Interest charges for an overdraft are typically higher than those for a term loan. Banks may require an overdraft to be secured on assets.

Example: ABC is a recycling organisation that collects unwanted office furniture from businesses and redistributes it to schools, charities and community groups. The company achieves zero landfill, creates jobs for disadvantaged people, and helps businesses to meet their corporate social responsibilities. The company employs 25 people at its head office and two warehouses and has franchises in three towns around the country. The funding package it secured consisted of two unsecured loans of €32,000 for three years at an interest rate of 9.5%. A €32,000 overdraft facility with an interest rate of base rate + 4% and an arrangement fee of €320 from another finance institute. The offer was conditional on Green-Works moving its banking facilities to the same finance institute..

Factoring / Invoice Discounting

Factoring or ‘Invoice Discounting’ is like contracting out collecting payment of your invoices. The advantage is that you get your money more quickly. The disadvantages are that you lose control of the repayment process and that you have to pay a fee for the service. It is useful if your clients are slow to pay you, if collections take a lot of time and effort or if you don't want to have to employ staff to do the work for you. These services are usually provided by specialist teams within the mainstream banks, and they will only be interested if you have a substantial invoice book.