TO
BORROW MONEY EFFECTIVELY,
loan brokers, finders, consultants, and potential borrowers need to
understand as many different methods as possible to increase the
likelihood that a lender will make a desired loan.
FOR
EVERY LOAN REQUEST, the
lender weighs many variables, such as type of loan, amount, interest
rates, repayment terms, borrower's collateral, job status, earnings,
credit score, credit history and other factors. To be an effective
loan finder or borrower, you need to know how to use this information
to secure the funds you, or your client, need.
THE
COMPENSATING BALANCE LOAN
ONE
METHOD THAT CAN HELP YOU, OR YOUR CLIENT, get
a loan is by using a “compensating balance.” This is
an amount of money that a borrower agrees to keep in an account with
the lender as a condition for getting the loan. Such loans are most
often made to businesses, although they may be provided for real estate as well.
THE
ACCOUNT CONTAINING THE COMPENSATING BALANCE usually
does not bear interest to the borrower, and
the
lender is free to use the money as it wants. If the borrower fails to
repay the loan as agreed, the bank can take the funds from the
account.
A
SIMPLE EXAMPLE
COMPENSATING
BALANCES ARE TYPICALLY 10%-20%
of the amount of the loan.
A
SIMPLE EXAMPLE OF THIS METHOD
would be where a lender agrees to make a $100,000 loan as long as the
borrower keeps a deposit balance of at least $10,000
(10% of the loan) in a savings, checking or certificate of deposit
(CD) account. The $10,000 is called the compensating balance.
HOW
IT WORKS
IT'S
NOT UNCOMMON FOR LENDERS to
subtract the interest and the compensating balance amount from the
total principal of a compensating balance loan. For example, on a
$25,000 loan at 8 percent interest for one year, the interest of
$2,000 (8% of the loan) and the compensating balance amount of $2,500
(10%) may be subtracted from the $25,000 principal. Thus, the total
amount the borrower receives is $20,500. This is only a general example.
Individual lenders and specific loans may vary.
SOME
LENDERS PREFER TO OFFER A LINE
OF CREDIT
rather than a regular loan
when a compensating balance is used.
DESCRIBING
THE LOAN
THE
NAME “COMPENSATING BALANCE” HASN'T CAUGHT ON
with all lenders, even though you'll find it in financial texts like
the
Dictionary
of Banking Terms and
Dictionary
of Business Terms. “Offsetting
balance” is another name that is sometimes used.
GENERALLY,
LENDERS WILL UNDERSTAND what
you're looking for when you describe the method—“an amount of
money the borrower agrees to keep in an account as a condition for
getting the loan.”
WHEN
APPROACHING LENDERS
about this kind of loan, be prepared to describe the method and
explain the type of arrangement you want. Give an example like the
one above if you need to.
SHOP
AROUND
AS
WITH ANY LOAN, IT'S WISEST TO SHOP AROUND at
many different lenders. If one lender turns down a request for a
compensating balance loan, the next one might make the loan that you, or
your client, need.
TO
GET THIS TYPE OF LOAN, YOUR BEST BET is to go
to commercial banks or credit unions. A list of commercial banks can be obtained from the Federal Deposit Insurance Corporation (FDIC) at fdic.gov. A list of credit unions can be obtained from the National Credit Union Administration (NCUA) at ncua.gov.
TIPS
FOR GETTING A COMPENSATING BALANCE LOAN
- The larger the compensating balance in the borrower's account, the easier it may be to get a compensating balance loan.
- To set up a compensating balance loan, the borrower should establish a deposit account with the lender where the loan is requested.
- Some lenders may offer a line of credit instead of a regular term loan. Borrowers should consider taking a line of credit, as it can be just as useful as a regular loan.
- Be prepared to describe the method and give the lender an example of the type of loan you have in mind, since the lender might not use the term “compensating balance.”
- It may be easier to get a compensating balance loan from a commercial bank or credit union than from other lenders, so these are good places to start. A list of commercial banks can be obtained from fdic.gov and a list of credit unions from ncua.gov.
- Look to large lenders and lenders with locations in your area.
- Shop around at different lenders. If one turns down your request, move on to the next.
- Keep the lender happy. The borrower should keep the full amount of the compensating balance in the account at all times. It may be helpful to keep more than this amount in the account, if possible.
- For the best chance at obtaining a compensating balance loan, apply for the loan through an existing business, rather than as an individual.
IF THE BORROWER CAN MAINTAIN THE AGREED-UPON COMPENSATING BALANCE amount, a compensating balance loan can be a useful tool to help fund a growing business or real estate endeavor.
For additional money-making tips and products, visit my official International Wealth Success website and browse our real estate and financing pages.
