How Do Business Lending and Residential Mortgage Lending Differ?

For residential mortgage and business lending, lenders want to be confident that the person or business has the means to make ongoing loan repayments. In most cases, the five Cs of credit apply to business loans and residential mortgages:

Character – In both cases, the lender will want to know the reputation and credit history of the borrower. This includes checking credit reports. For business lending, both personal and business credit reports are reviewed.

Capacity – Lenders want to make sure the person or business will be able to make the scheduled loan repayments. In both cases, they assess financial health. For business lending, it’s common for the borrower to request financial statements, such as a balance sheet, income statement (profit and loss) and a cash flow statement. For new businesses, traditional business lenders will often want to see a business plan as part of the application. 

Capital – For a first home buyer, a deposit of up to 20% is required. Commercial property loans often don’t cover the full cost of the loan, so a cash deposit is required in many cases. Some lenders will lend 100% of the value if there is a guarantor or if a residential property is used as security. For most other business loans, there is no deposit required. 

Collateral – Secured business loans require collateral of some form. Many SME owners use residential property as collateral for their business loan. Some lenders have curtailed this practice while others have lowered their LVRs, reducing access to funds for business owners. Other loans, such as equipment loans, use the asset being purchased as collateral. If the business is unable to make payments, the asset will be taken back by the lender and sold to recoup the funds. Unsecured business loans don’t require collateral. A few examples include unsecured business overdrafts and cash flow loans. 

Conditions – These are the lender’s conditions for providing the loan and include the repayment schedule, the interest rates and fees, and anything that needs to happen before the loan is granted and during the life of the loan. In general, conditions apply to both residential mortgages and business loans.

If a mortgage borrower meets the five Cs of credit, their first priority is getting the best interest rate. For obvious reasons, mortgage borrowers want to minimise the interest they pay over the life of the mortgage. This makes sense but does not apply when seeking a business loan for several reasons. 

First, many types of business loans have shorter terms ranging from 1 to 5 years. So, even at a higher rate, the interest paid won’t pay as much over the term of the loan. 

Second, the business case for the loan and the results that the loan can create are more important than the interest rate. With residential mortgage lending, it’s about the value of the property and the ability of the borrower to make repayments. With a business loan, the funds might be needed to cover a cash flow shortage or taking advantage of an opportunity to grow the business. 

Third, the timeframe for seeking business finance can be very important. In many cases, business owners need quick access to funds. With mortgage lending, urgency is not usually a factor.

Let’s say a construction company wins a contract for a local council project worth $600,000 that will take one year to complete. The business owner wants to take on the work but needs $400,000 to fund the project and needs funds within two weeks of winning the contract to get the project started. The funds will be used for a range of project expenses including paying wages, buying equipment and purchasing material for the work. 

The business owner could approach a bank and apply for a term loan. Although the rate for such a loan is competitive, at around 6% per annum, the application process is time-consuming and it can take up to eight weeks to get an answer. In addition, the bank will require some form of collateral, usually residential or commercial property. For fast, short-term finance needs, a bank term loan is not the right solution as it will take too long to get the money needed. 

With Moula, for example, a short-term cash flow loan can be approved within 24 hours. In this situation, the construction business would be able to get the funds needed to get the project moving quickly. The interest rates will vary based on the company’s profile. With a Moula loan with an interest rate of 0.61% per fortnight and a one-year term, for example, the interest payment would be $33,744 and fortnightly payments would be around $15,000 over the 12-month term. With Moula, there’s no penalty for paying off the loan early. So if the business is able to pay off the loan in nine months, the interest amount paid would be less. 

Although the interest rate on the bank term loan is lower, the approval time and collateral required are prohibitive. In order to take on the project, the business owner would need to get quick finance which will have a higher interest rate. The speed of approval is one of the big advantages of unsecured business loans. 

Retail businesses tend to be cyclical, with highs and lows throughout the year. For example, a retail gift shop owner wants to get ready for its busiest time in November and December and needs $100,000 to purchase inventory in August which it will sell for $200,000 by the end of December. Although a bank loan could have a lower interest rate, the approval process and collateral required is often prohibitive. With such a short term, many traditional lenders wouldn’t consider this type of loan. Many would charge fees and penalties if the loan was repaid early. In addition, many small-to-medium businesses often get rejected for business loans. According to a recent survey, 40% of SMEs have found it challenging to get the finance they need to grow. 

These hypothetical examples show that the interest rate is not the most important factor when helping clients get the right finance for their needs. As Moula Partner Jason Basseal from Loan Market noted: 

“The most important thing is to understand how fintech lenders work. Don’t try to transfer the traditional home loan mentality into the business lending space. The most important thing is the solution, not necessarily the rate. Be prepared to expand your horizons to understand what your client needs, and how you can help them to grow their business.”