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Applying for a Church Loan

Important tips for securing the funds you need

    Added January 01, 2007

As published in Worship Facilities, Jan/Feb 2007

Church loans are classified as commercial loans, but experienced church lenders understand that standard commercial loans have features, covenants and conditions that may not be appropriate for churches. If your church needs new funds for construction, the acquisition of land or buildings, or to refinance existing debt, look for a lender that specializes in this unique market.

Most church building and finance committee members have no experience with commercial lending and assume that a church loan is going to be similar to a residential mortgage. Some of the significant differences between home mortgages and commercial loans relate to the term of the loan, the amortization period, the pricing indices, and the loan covenants.

The Basics of Commercial Loans
Commercial loans are typically amortized over 15 to 25 years, whereas home loans are usually 15 or 30 years. However, it is important to note that commercial loans are not "fully amortizing" like home loans. In other words, commercial loans typically mature, become due and payable, or "balloon" in 5 to 10 years. The term of the home loan is typically equal to the amortization duration.

Like home loans, commercial loans are available with variable, annually adjustable, and fixed interest rates. Fixed interest rates are available in various durations. Interest rates are typically calculated based on an equation tied to a published index. For example, variable rates are often linked to the Prime rate or the 30-day Libor. The rate may be quoted or offered as "the 30-day Libor plus 1%, adjusted monthly." Annually adjustable interest rates are often linked to the Treasury Bill.

With commercial loans, fixed rates are typically tied to an index of like maturity.

For example, a five-year fixed rate may be based on the five-year U.S. Treasury Note or the five-year Swap. The home mortgage market is based upon highly standardized lending criteria. Given the standardization and the sheer size of the market, it is somewhat easier to project loss rates. There is also a very active secondary market for home loans. As a result of these factors, home loan interest rates are usually lower than commercial loan rates.

Residential mortgage loans contain virtually no ongoing performance or reporting covenants. In contrast, commercial loans almost always do. For example, lenders with limited experience with church lending will require the borrower to maintain a specified debt coverage ratio (annual operating cash flow available for debt service to actual required debt service). As evidence of such, the borrower is required to provide the lender with annual financial reports. These reports typically must be prepared by a Certified Public Accountant at the borrower's expense. The requirement may be for a compilation, review, or a full audit depending upon the size of the loan or other lender criteria. It is also common for commercial lenders to forbid the borrower to incur other secured indebtedness or further encumber the primary lender's collateral, perhaps via a second mortgage, without the lender's prior written consent. The concern here is that an unknown secured lender could initiate a foreclosure action. In such an event, the primary lender may be forced to join the foreclosure action in order to preserve its collateral rights.

It is important to work with a lender that has a history of working with churches. Experienced church lenders will have customized loan documents which exclude loan covenants that are not appropriate for churches. Moreover, committed church lenders will offer you loan products and features tailored to meet the needs of churches. For example, prepayment without penalty, the ability to layer on additional debt for subsequent building phases, and the option to re-amortize the loan without having to reset the interest rate following prepayment are some loan features that church management may seek.

Application & Underwriting Process
The application and underwriting criteria for home loans is highly standardized. The ready securitization market for home loans (i.e., Ginnie Mae, Fannie Mae, etc.) is evidence of this standardization. In contrast, historically church lenders have almost never securitized and sold off their church loan portfolios. Church lenders typically live with their church relationships through the life of the loan. As a result, each church lender's process and criteria may be slightly different.

To apply for a church loan, you should prepare a synopsis of your financing request. If funds are for construction, describe the type of facility to be built, the size, the anticipated break-ground date, the estimated cost, etc. Provide financial statements (income and expense statements as well as balance sheets) for each of the last three years, plus interim statements for the year-to-date period. In addition, church lenders will want to know about your church's vision and ministry. Provide a brief history of your church, touching on any leadership transitions as well as physical plant development. Leadership is one of the key factors church lenders evaluate. Provide a resume for your senior pastor and the business administrator. A copy of the church's articles of incorporation and bylaws are helpful, along with a list of board members' names and their occupations.

Lenders will also want to see that the church's attendance trends are stable or increasing. You should provide average worship attendance figures for the past five years, breaking out adults vs. children. Some lenders ask for the number of giving units.

Face-to-Face Lender Meeting
Once you've prepared your financing package and found an experienced church lender, be prepared to visit with the lender. Generally speaking, the lender will come to you — they take the time to meet with you on-site to make a personal connection and to get a first-hand look at your property. Both the senior pastor and the business administrator have important roles to play in the meeting. Outside parties such as consultants and contractors should not attend the first meeting. The banker has to make a decision about entering into a long-term relationship with the church and will, therefore, want to get to know the church leaders first. Board members or other key staff members may be included in the introductory meeting if available.

In the meeting, the senior pastor should be prepared to discuss the past, present and future vision and ministries of the church, and how they relate to the proposed loan (if the loan is to fund new facilities). While he or she may delegate the details to others, the senior pastor should demonstrate a general understanding of the project budget and timeline. The senior pastor should also define the church's formal decision-making process for the proposed undertaking, as well as seek any necessary informal counsel. He or she should feel free to share personal views and methodologies regarding tithing and fundraising. The senior pastor should also summarize the church's budgeting process and detail how often board meetings and other similar activities are held.

The business administrator should provide a general overview of the church's day-to-day operations and procedures, internal accounting systems and checkwriting authority. He or she must demonstrate a good knowledge of current and historic attendance and giving trends, as well as of the details of current and past capital pledge campaigns. In the case of construction, the business administrator should display a thorough understanding of the project budget, timeline, and related contractual agreements. He or she should be prepared to answer questions about any financial information that was provided to the lender.

Next & Final Steps
The loan application process can take as little as a few days or as long as a few weeks, depending on how thorough the original loan application package is and how available the church is to answer questions for the lender. Once the lender has favorably evaluated the loan application, a term sheet will be offered to the church. The lender will preferably review the offer in person to explain various pricing options, terms, conditions, and covenants. Once the church accepts the financing offer, the bank will move forward with formal loan approval. This process may involve obtaining a little more information, and typically takes a week or two.

In preparation for closing the loan, the lender will need to engage environmental consultants, a title company and possibly an appraiser. The loan closing process may take up to six weeks. Experienced church lenders can work with their borrowers to shorten the timeframe from application to closing if necessary but, generally speaking, the application process should begin no later than 90 days before your break-ground date. It is wise to make your final lender selection within 60 days of your desired loan closing.

Regarding the execution of construction contracts, it is wise not to enter into an agreement until you have a firm financing offer in hand. Similarly, it is best to engage an architect to design new facilities only after first obtaining an estimate of your church's "debt capacity" from a lender. There is no sense in spending good money on plans for facilities that you cannot afford to build.

Church staff that start working with an experienced church lender well in advance of the need for funding will be well served.

Marianne Berlan is vice president and manager in charge of new business development for the Church Loan department at Bank of the West. She has more than 10 years experience working exclusively with churches. Berlan earned an MBA from the University of Alberta in Edmonton, Canada.