By Michael Klein, CEO Freedom Financial Funds, LLC
With so many new lenders in the market, borrowers have more choices than in recent memory, but most borrowers are not taking full advantage of this opportunity. Most simply shop for the cheapest lender instead of shopping for the best lender for their transaction. This shopping pattern is fascinating because, on average, it does not match the rest of these borrower’s lives. Most borrowers seek to buy the best car, go to the best restaurants, shop for the best clothing or go on the best vacations. Yet, when it comes to borrowing, they focus on price, instead of value.
Many borrowers think money, is money, a loan is a loan and quite frankly, that is correct most of the time. But most of the time is not all the time. When everything in the economy is going well, there is rarely a problem. Loans get funded, terms seem fair (and usually get more liberal as the economy expands), and lending staffs are accommodating. However, when the economy shifts, and becomes more challenging how will that easy-going source of cheap money behave?
The answer is critical because borrowers have a lot at stake. Further, the answer will determine the real value of the lending proposition. Lenders famously have the tightest underwriting when they should have the loosest and vice-versa. Thus, lenders are tightest when markets are at their lowest valuations and loosest when they are at their highest. It must be human nature. However, this phenomenon is exactly what a borrower should be most concerned about because it is exactly the opposite of what is in the borrower’s best interest. Borrower’s that focus on creating value and preserving capital know that the best markets for them are during the times when everyone is scared to invest. It should also make sense then, that the best lenders are those that remain in the market when the best buys are available. Of course, this is the opposite of what happens with the substantial share of lenders.
How do lenders stay in the market in good times and bad? By staying consistent in their underwriting and not becoming liberal at the most dangerous point in the cycle (hint: when everyone is confident, and prices are high). Borrower’s should question lenders about how they performed during the last downturn (and the downturn before that, too). Lenders ask borrowers a lot of questions, so why not ask for some information from the lender since as the borrower, your equity protects the lender and could be at substantial risk if your lender panics if the economy changes during the course of your deal.
We tend to forget bad news, especially if we were not directly impacted by that news. Oh, we may have known people that were impacted but that was just removed enough from our day to day that the true pain was not felt or internalized by us. Thus, many borrower’s have now forgotten the number of halfbuilt projects that littered most cities in 2008-10 and 1988-1992. These projects were stopped, in many cases, because the lender panicked, ran out of funds or was seized by its regulator. These projects were often lost by the borrower because without the lender funding, they could not finish. But with completion guarantees, personal guarantees and a multitude of other commitments, many borrowers were destroyed because they could not complete the project without funding and the project would not be funded unless it was completed – a real Catch 22. Knowing your lender and having some idea of how they may behave likely would have saved borrowers millions.
As a borrower, it is critical that you understand if your prospective lender successfully navigated its way through a full economic cycle as a lender. Is lending its only business? Can you obtain references from borrowers that were with the lender when the economy was down?
As a borrower, you need know the answers to these questions because like all things, the price of a loan does not necessarily equal the value of the loan. As borrowers need to do due diligence just as lenders do.
