What to Look for in a Commitment Letter When Choosing a Bank
Often times when you apply for a practice acquisition loan, you (or Practice Impact on your behalf) will send the finance package to multiple banks. This allows you to compare the banks’ offers and choose the one which will best suit your needs. Once you submit a finance package it normally takes 2 to 2 ½ weeks to receive a loan approval and commitment letter. Most banks have an underwriter thoroughly review your loan proposal before submitting an offer which is why it takes so long.
Once you receive all of your commitment letters there are several items you should compare. Many of these are listed below:
- Is this actually a commitment letter approving your loan? Some banks will send an offer letter before underwriting the loan. This is not an approval letter to loan you the money, but more of a pre-approval based on your credit score. This letter usually shows the loan amount and interest rate as well as some of the other loan details, including the fact that the loan request has not gone through their underwriting process yet. When you receive this type of letter you need to be aware that the loan can still be denied before closing. This is not to say that you will not get a good deal or that there is something wrong with using a bank that does this; it just means that you need to make sure that you understand this letter and all offer letters before making this big decision that will impact you and your practice for years to come. If you are genuinely interested in using a bank that offers this, you should ask them to underwrite the loan before you commit to them and shut out any other bank prospects. Don’t accept this proposal just because it’s the first one that you receive; it may or may not be the best offer for you.
- Amount of Loan: Is the amount 100% of the purchase price or do you have to put money down or ask the seller to finance part of the loan? Are there additional funds for working capital? Is the working capital worked into the loan or is it a separate loan?
- Interest Rate: What is this rate? Is it a fixed rate for the life of the loan or will it vary?
- Is there an interest-only period? PI requests 6 months of interest only payments to allow you to get situated in the practice and start collecting your receivables before having to make a full payment. This greatly assists your cash flow during the first few months of ownership.
- How long is the loan term? The shorter the term, the lower your interest rate. Longer loans will have lower monthly payments which may look great but you have to remember that spreading out your payments will ultimately cost you more. Practice Impact generally recommends a 7 or 10-year loan for most doctors. Some banks do offer a 15-year loan, but you should always consult your accountant before making this decision to see what is in your best interest. If you can easily pay off the loan in 7 – 10 years then you should probably not drag it out and take a 15-year loan.
- Is there a balloon payment at the end of the loan? This may lower your monthly payments but you will have to carefully plan for the larger payment at the end of the loan or plan to refinance the loan when the balloon payment is due.
- Will the bank require you to hold your accounts and do your business banking with them? Some banks require this, others don’t and some drop this requirement if there are no branches in your area. With the implementation of individual check scanners and online banking, this is not as much of a concern as in the past, but it is still something to consider.
- Collateral: Will the bank require any collateral besides your personal guarantee and the first lien position on the practice? Banks who specialize in dental loans typically will use the practice as collateral, but a local bank may request something additional including using your home or another practice you own as collateral or may want a spouse to be a guarantor.
- Closing Fees: These vary from a few hundred dollars to several hundred for an acquisition loan and can go up to a couple of thousand for a real estate loan. The fees depend on the bank, type of loan and will increase when a real estate appraisal needs to be done.
- Insurance Requirements: Depending on the bank and amount of your loan, you may be required to purchase disability and life insurance in addition to your contents insurance. If you are required to purchase this additional insurance you will probably also need to assign it to the bank so they can recoup your unpaid loan in the event of your disability or death.
- Pre-Payment Fees: Is there a fee if you pay off the loan early? Sometimes this can be waived, but there will be some sort of fee in most cases. This fee can be based on the amount of time left on the loan, the original or current balance, or even the current interest rate vs the interest rate on your loan. Be sure to understand this – even though you don’t anticipate paying off your loan early you never know when something may come up. You may even want to refinance with a different bank at some point. This repayment fee may greatly impact this decision.
- Conditions that need to be met before closing: Not only will the bank require to have a copy of your insurance policies, they will also need paperwork verifying your entity, such as Articles of Incorporation, Operating Agreement, and verification of your tax id number. They may also want a copy of the purchase agreement and lease. Some banks only request a copy be given to them at closing. Practice Impact works closely with the banks to ensure they get all of this info as soon as possible and provides a copy of the purchase agreement and signed closing documents right after the closing so you do not have to worry about sending this information and can focus on taking ownership of your practice.
- Expiration Date: Because interest rates are constantly changing, banks can only hold your rate for a limited time. Check this date on your commitment letter and make sure your banker knows when you are scheduled to close so she can make sure your offer does not expire too soon.
Although these may not be all of the items to consider when choosing a bank, it is a good overview. The most important thing to remember is that you should always carefully review all of your commitment letters. Make sure that you understand the offer and implications for you and your business. It’s also advisable to have your CPA or accountant to review it on your behalf. And, of course, ASK QUESTIONS! Practice Impact has worked with several different banks and can answer many of your questions regarding financing. If we can’t answer it then we can certainly put you in contact with the correct banker to answer all of these questions. We want you to accept the financing deal that is the best for you, but only you can make that decision so please be informed before making it!