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6 Common Church Loan Pitfalls

Church Finance Basics

Whether you’re a first-time borrower or are already familiar with commercial lending, this list of pitfalls will help you spot potential dangers when looking for the right church loan. With an understanding of these risk areas, you will be better prepared to enjoy smart financing for your growing church.

1. Borrowing too much

A common pitfall churches face when borrowing money is not knowing how much they should borrow. This can place a church at risk of being allowed by a bank to borrow too much, to the detriment of ministry. The reason for this is that most banks lend primarily to businesses rather than churches. The ratios used to assess businesses often don’t apply to churches because they are structured differently. Using wrong evaluation methods can skew the picture of a church’s available income. To avoid this, a church first needs to understand the financial scope of its project(s) and true borrowing capacity based on ratios that suit churches. This is one important reason your lender needs to be able to see your church through the lens of ministry to fully understand what a financially healthy church looks like and assess accordingly.

2. Hidden costs of short-term financing

Just as in residential lending, the shorter the loan is, the lower the interest rate will be. However, chasing the shortest term with the lowest rate is not always in the best interest of a church in the long run. Although short-term mortgage products—typically considered 5 years or less—can have enticing introductory rates, there are many hidden costs to consider. If the loan is not paid off by the end of the term, it will have to be refinanced. Of course, there are closing costs to consider, but refinancing a short-term loan also increases the time that it takes to pay it off. In addition, each time a loan is refinanced, the payment schedule starts over from the beginning, with more interest and less principal in each payment.

3. Hidden risks of short-term financing

Along with hidden costs, other risks also come into play with short-term loans. For example, each time the loan needs to be refinanced, the church will have to re-qualify for the loan again. If there are changes in property value, revenue, personnel costs, etc. a church could find itself facing foreclosure if it can’t find a lender who will refinance the loan – even if the church is able to make the payments.

4. Interest rate risk

After the residential mortgage crisis of 2007, people became overly cautious toward adjustable rate mortgages. However, in commercial lending an adjustable rate mortgage is standard. Although some short-term loans have fixed rates, a church will almost certainly need to refinance at the end of the term. It will then be subject to whatever the market interest rates are at that time. A more stable option for churches would be a longer term, adjustable rate loan with rate caps in place both for the adjustment period and a maximum for the life of the loan. This guarantees stability with the loan, regardless of index rate changes.

5. Prepayment penalties

These are also called “interest rate termination fees” or “other third-party fees.” A prepayment penalty charges a fee to make extra principal payments, whether a little at a time with each payment or all at once with a refinance. For example, when index rates drop and a church wants to refinance to take advantage of the lower rates, they may find themselves locked into their current loan because of prepayment penalties, which can be costly. Being unable to refinance without incurring such a fee could negatively impact the church’s financial capability for ministry growth.

6. Restrictive covenants

Numerous issues are often found in the fine print of a loan, the affects of which churches may not understand until it is too late. Before signing, be sure to study all the details of a loan agreement and the ramifications they could have on ministry.

Now that you better understand these six areas of risk in commercial lending, you’ll be equipped to make a more informed financing decision that’s in the best interest of your ministry.

Overwhelmed? We’re here to help.

It is our privilege to be a trusted resource for churches, and we would love to be of assistance to you – whether it’s evaluating your borrowing capacity, reviewing a loan offer you’ve received from a bank or credit union, or helping structure your plans for expansion. Call us today at 888.599.6015 to speak with a qualified loan representative.

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