What Is Permanent Financing?
Permanent financing denotes a long-term mortgage loan, which functions similarly to longer-term equity financing or debt. Most often, borrowers secure it with a fully stabilized and operating real estate and use it for buying or developing machinery, factories, and other long-lasting fixed assets. As these types of assets pay off over a longer period, permanent financing seems to be the best fit for businesses that may be unable to pay the principal back immediately. Shortly, permanent financing enables smaller companies to expand their operations without destabilizing them financially.
In permanent financing, borrowers obtain the money from a third-party lender to finance a specific project or acquire related assets. In exchange for the borrowed funds, they can either offer their company’s assets or, in some cases, give away part of their ownership in the company. Each option has its advantages and disadvantages, so company owners and directors have to weigh them before making their final choice.
Permanent loans usually have fixed interest rates with a longer loan term, often exceeding seven years. An interest-only payment period throughout the complete loan term or only part of it may or may not be present. But almost all long-term loans include a penalty for prepaying them before their official due date. Some common examples of penalties are defeasance and yield maintenance.
Defeasance occurs when a lender releases a borrower for their debt obligation and replaces the lien on the property with acceptable alternative collateral expected to yield them a comparable cash flow. On the other hand, yield maintenance denotes a prepayment penalty calculating method that evaluates the difference between the loan’s prevailing and contractual interest rates so that changing them will impact neither the borrower nor the lender. Furthermore, many permanent loans include an initial lock-out period, which forbids the borrower from prepaying the loan.
To better understand permanent financing, it is noteworthy to see how it compares to short-term financing. The two differ in how long and how borrowers repay them and finance with them. Borrowers must repay their short-term loans within 12 months. On the other hand, permanent financing provides them with greater flexibility, and they can pay off their longer-term loans within several years or even decades.
Regarding the repayment schedule, borrowers usually repay short-term loans with one lump-sum amount. Meanwhile, permanent financing enables them to decide on a repayment schedule. For example, they can send money monthly or annually or opt for making smaller lump-sum payments periodically.
As for financing, businesses use short-term loans to cover daily operations, making them particularly suitable for shorter projects or seasonal businesses. For example, a Christmas shop can get short-term financing to purchase materials and cover payroll and leasing costs. They can then use the generated revenue to repay the loan.
Conversely, borrowers use permanent financing to acquire fixed assets that the company will use long-term. For example, the same Christmas shop may want to create a huge ornament to attract more customers or build a production factory. These may be costly endeavors, but they are justifiable if they bring crowds into the shop and increase its output. The generated annual revenue may be insufficient to pay the lender off, but the business can do so via small lump payments over the upcoming several years.
