Are You a Direct Lender?

The question, “are you a direct lender?” pops up from business owners with the idea that being a direct lender is going to get you a better deal. People think “direct” means there are no middle men which will increase the cost of funds. Once you understand the process and flow, you will learn what a large misconception this truly is.

Let’s review the process of a direct lender (commercial bank). By definition, a direct lender uses its own money to fund your loan. They receive your application, which is often solicited by a sales person, and then handled by an account manager which makes sure all the required paperwork is complete. Then your application goes to credit review which is sometimes combined with final underwriting or not. If credit review reveals things like defaults or late mortgage payments then the red flag goes up and your package never makes it to underwriting because they already know it will be declined.

If your direct lender declines you, then you get a nice phone call and letter stating why. Sometimes you get advice on how to improve your status but you certainly never get a referral to another lender to see if they can approve it. Direct lenders are in the business of “creating and maintaining relationships” which means they are not about to refer you to a competitor – that won’t happen. So your loan process stops there, with no options, and you’re done.

If your direct lender approves you then great; you get a term sheet with all the requirements to get the loan. You often have to make a deposit which means you’re not getting 100% financing and you may have to regularly report the performance of your business by supplying updated financial statements; this irks many business owners. That loan will also include their fees and overhead. The sales person, account manager, credit review people and underwriting all get base salaries plus commission which is all overhead you pay for. So that 6% loan jumps up to 10% if you consider deposits, fees and sometimes compensating balances you have to maintain in their institution – can you see the picture more clearly now?

Let’s review the other option for funding your business loan; the 3^rd party lender, broker or brokerage firm. The broker solicits your application, reviews it for completeness and gathers the necessary financials. The credit team then analyzes the financials and determines 2 to 3 of the best lenders which are most likely to approve it with good terms. Brokers fund through wholesales lenders, which only work with brokers since they don’t have a front office, and private investor groups, which fund specific markets. Brokers do not use their own funds and this is a very positive aspect for the business owner.

The next step is either an approval or decline from the lenders which review your application. An approval will not require any compensating balances or reporting and will be 100% financing since no deposits are required. These lenders focus on the specific deal rather than making sure you’re putting enough money in your kid’s college fund. If your application is declined then other lenders are brought into play – there are often many alternatives to choose from since brokerage firms are not “single source” lenders. Brokers are not afraid to reach out to numerous lenders to get your business approved which is the reason why brokers have a much higher success rate than direct lenders.

Since the direct lender has overhead and commissions to pay for in your loan, then what does the broker cost you? In most cases, everyone in a brokerage firm works on commission so there are less layers of people to contend with; the broker often solicits the business and performs initial credit review and the credit people do the final packaging – that’s it. From there it goes to the underwriters of the specific lender reviewing it. There are less salaries and overhead to factor in and the motivation of the broker firm to get your deal approved is clear – unlike the direct lender; there is no salary to cushion a declined application, brokers simply don’t get paid unless they approve your application.

So a 5% approval from you direct lender, of which you make a sizeable down payment raising that true rate much higher, or an 8% flat rate from your broker, which only requires first and last month with a couple hundred dollars in documentation fees, it is clear which makes more sense. Not all cases work exactly this way but many of them do. The key is to consider all the factors when making your decision as to where to submit your application.