Whats the biggest fixed cost associated with owning an airplane? Insurance, you guess? Not!
For most of us who have leveraged ourselves to the hilt to slip Earths surly bonds, the interest that we pay the bank is our biggest cost, although we hardly notice it.
If you borrow $3,000,000 to finance one of Cessnas nifty CitationJets, your interest cost will run you around $700 per day. So who cares how much fuel the airplane uses? But even if youre only borrowing enough to cover the last $100,000 of your used Beech Bonanza, your note will probably cost you around $1200 per month.
The good news is that interest rates are the lowest theyve been in many years and theres intense competition to loan you money. A recent finger walk through the finance section of Trade-A-Plane yielded more than two dozen ads for companies looking to lend money for airplanes.
These people are serious, too. Most of them have between eight and 25 ads sprinkled through the rest of the issue. In fact, the sheer volume of choice may cloud the issue of which lender and type of loan to pick.
Lots of Variety
And theres seemingly endless variety out there. The simplest to parse is a bank with a dedicated aircraft loan department. Here, youre dealing directly with a loan underwriter. These include such names as Cessna Finance Corp, Textron Financial, UnitedBanks Aircraft Finance Group, BankBoston and MBNA, to name a few of the larger ones.
There are also a good number of smaller banks with dedicated aircraft loan departments, such as First National Bank of Pryor, Red River Bank and Iowa Trust.
While guidelines vary considerably from one bank to another, loan officers are interested in lending to people who will probably pay them back. Its just good business. To determine if youre creditworthy, the lender generally looks at two things: The first is your ability to repay the note, as expressed by the ratio of your debt to your income.
Theyll examine your recurring monthly payments, (mortgage, car loan, credit card, child support and the like), add in the aircraft loan payment and compare it to your monthly income. In most cases, lenders are looking for your monthly payments (including the aircraft loan) to add up to something less than 50 percent of your adjusted gross income.
The second marker is what bankers refer to as your willingness to repay your loan as expressed by your credit history. Banks checking out loan applicants routinely do credit checks to make sure that youre in the habit of paying your bills on time. If you pass both of these tests, are innocent of bankruptcies, youre whats known in the trade as an A credit and will probably be approved. The term A credit, although not universally used by lenders, is understood by all. The better your credit, the more your options.
Not Banks At All
Many of the lenders that you find in Trade-A-Plane and elsewhere arent banks, however, but loan originators. The originator takes care of advertising, applications, initial credit analysis, gathering of documents and making sure that the title of the airplane is free of any liens.
In most cases, the originator sends the paperwork to a bank underwriter for final approval. Once the loan has been approved, the originator does all of the legwork to make certain that paperwork is filed with the FAA, documents are exchanged and to otherwise expedite the closing.
One originator, U. S. Aviation Finance, actually has the ability to initially fund its own transactions. According to USAFs David Savoie, this allows him to take care of his customers without the extra step of going to an underwriter.
Savoie then sells the completed loan to the bank that he is associated with and, in fact, used to work for.
Among originators, there seem to be two distinct groups. Some, such as USAF, are associated with a bank. These originators handle all of the initial work and stay involved in any service that your loan requires during its full term. Aviation Capitals Rocky Morse told us, I stay involved for the life of the loan. If you need a payoff figure five years down the road, want to run numbers on a different airplane, or any other help, I am the guy you call.
The originator is paid by the bank periodically as the loan matures. In some cases, an originator may have agreements with several banks, allowing him more flexibility in loan size, terms and credit requirements.
Group two includes the loan brokers, who may work with a specific bank, but who often will shop around with other lenders, including some you might go to yourself directly. These folks sell your completed loan to a bank just as home mortgage originators sell off your mortgage to Fannie Mae.
They make their profit on the fee that they charge you and on whatever the bank pays them for the cash flows that your loan represents. Two brokers told us that they would review an applicants paperwork and decide which bank would be most likely to provide the buyer with the best terms. Both said they frequently would go to more than one bank for customers with tough credit.
Yet another source of finance are the so-called equity lenders. Equity lenders dont look into your creditworthiness at all, but lend based strictly upon the value of your airplane. The loan agreement is written in such a way that theyre able to repossess your airplane with a minimum of fuss if you stop paying them.
Joda Partnerships is one of these lenders. Joda charges a much higher rate of interest than other lenders and may charge as much as 3 percent for closing costs, but they will lend to anyone with a valuable aircraft. Anyone.
Bear in mind that the traditional banker has two sources of security: Your credit, often backed up by a personal guaranty, as well as your collateral, usually the airplane. The equity lender has only the airplane, so he charges more for the additional risk hes taking. For people with bankruptcies or other serious problems with credit history, however, these guys may be not just the best deal in town, but the only deal.
Each group, of course, argues that it offers its customers a special edge. The originators that we spoke with, for example, were all knowledgeable about aviation, as well as lending and most tout this as the key advantage they bring to the table.
The bank aircraft loan department people whom we spoke to were primarily pilots, although in some of the larger banks there seemed to be a layer of clerical people handling initial inquiries. As one northeast lender put it, You shouldnt have to spell HSI for these people.
Since automated phone answering machines are one of our pet peeves, we would probably not borrow from a bank that made us listen to more than one menu, unless the rate was right. There are too many good deals out there to settle for irritating service and clerical noises. To understand the deals, you need to understand the terminology. Like people in any profession, bankers have their own set of buzzwords. There are two terms that bankers toss at you while describing their products that sound alike and deserve special mention.
The first is amortization, the rate at which the amount of the loan, both principle and interest, is paid off. Amortization for a new airplane may be as much as 20 years, while for a used airplane it may be 15 years. This should not be confused with the term of the loan, although the two usually run in parallel. The term of the loan is the actual length of time which your loan agreement gives you to pay it off.
The array of loan options is almost as diverse as the sources of funds. The simplest to understand, and currently most popular, are fixed-rate loans. Historically, banks have charged more for fixed rate loans because they face the risk that during the term of the loan, prevailing interest rates will rise and they will be forced to pay depositors more than they are charging borrowers.
The longer the term of the loan, the greater this interest rate risk is. The Federal Reserve has lowered rates three times in the past year. Rates are at historic lows and there is currently very little spread between variable and fixed rate loans.
Two banks told us that their current variable rate deals were priced higher than fixed rates. Among providers of fixed rate loans, most were willing to lend for up to 20 years on new airplanes and 15 years on used airplanes.
The actual loan terms vary considerably. Because it lends strictly on the collateral, Joda Partnerships typical term is two to three years. Typically, fixed interest rates increase with the term offered and decrease with the loan amount.
If youre borrowing $1,000,000, youll pay a point or more less than the guy borrowing $100,000. One banker whom we talked to offers his clients the choice of paying an up-front origination fee in return for a lower rate.
Over the course of a 15-year loan, the saving amounts to thousands. Longer term loans are a way to lower your monthly payments, but it also means that youll spend more time paying off the airplane and youll rack up more interest and have less to show for it if you sell the airplane early.
Like a home mortage, each payment is composed of an interest component and a principal component. Early in the loan, the majority of each payment is interest, much as it is in a home mortgage. Several lenders told us that although they would offer 20-year terms, they dont recommend them for smaller notes, since the principal pays down so slowly.
Another reason for the current willingness of aircraft financiers to offer longer term fixed-rate loans is that the loans are unlikely to go to maturity, the way that home mortgages do.
Everyone that we talked to agreed that the average life of a loan was between two and three years. Most owners change airplanes, refinance or give up flying altogether within that time period.
Variable Rates, Too
Variable-rate loans are also available from many sources and in a wide variety. A variable-rate loan is one in which the rate varies with a given index, often the prime rate charged by New York banks. The rates may be adjusted as frequently as every month and as infrequently as every five years.
The advantage of variable-rate loans has traditionally been price, since banks are not exposed to the risk of interest rates going against them and dont need to charge a premium. We found several variable or floating rate deals that were lower than fixed rates and were adjusted at five-year intervals. One banker who offers this product told us that he had very few loans that ran long enough to reach the adjustment interval.
There are also combinations of fixed and variable rates, often known as blended rates. In many cases, the note will be fixed for some period, say three, five or even seven years, and then will float monthly or quarterly in relation to prime rate for rest of the term. These may be a good deal if youre certain you wont be in the airplane or the note for long.
Then theres the balloon payment. The balloon occurs when the term of the loan is less than the amortization. For instance, one lender told us that she frequently arranges loans with a fixed-rate seven-year term, amortized over either 15 or 20 years.
Naturally, if youre leisurely paying off a note as if you had 20 years to do it, youll have some left over after only seven. This remainder is the balloon. If you borrowed $100,000 for five years at 9 percent and paid it back on a 10-year amortization schedule, you would owe $62,000 at the end of the term. Ouch!
The financial cliff the balloon represents means that this sort of loan isnt for everyone. And maybe not anyone, given the other deals available. But if youre not planning to own the airplane beyond the initial period, its yet another way you can minimize your monthly payments.
Interest Adds Up
Most all of the products that we found, whether fixed or variable, are variations on the simple interest loan with daily accrual. Interest that isnt compounded is known as simple interest. Each month, you pay interest on the remaining outstanding amount of principle.
Daily accrual means that interest is added up against the principal amount each day. If you make your payment one week late, seven days of interest will be subtracted from the amount youre paying toward the principal amount. If youre late every month, youll still owe some principal at the end of the loan.
What to Do
So, faced with this array of choices, whats the best route towards financing the light-alloy levitator of your dreams? David Madden of UnitedBank offered the following advice to anyone shopping for aircraft financing: Your banker should be a consultant, and if hes not, you should go somewhere else. The consumer should walk away feeling like he got a great deal and should understand what he got. Good advice, we think.
We recommend the following procedure: Start with your own situation. The two biggest questions for most of us are: What can I afford every month? and how long will I likely own this airplane? Longer loan terms reduce monthly payments, as do some of the variable and blended rate programs.
If you think that youll win the lottery in three years, go for the balloon. Otherwise, pick another loan type. The next step is basic fact-finding. Start by asking around among pilot friends, calling lenders that have ads in trade magazines and finding out whos who and how the deals work.
A phone call will usually give you the lay of the land. Many of these folks have Websites and you can get applications and lots of other information right off the net. (See the table on page 20 for a list of phone numbers.)
Banks tend to specialize by type of aircraft. Just about everyone will finance fairly recent factory-built airplanes. In some cases, lenders look for higher downpayments on older airplanes, especially twins. If you own a warbird, you probably dont need to worry so much about which bank to use. You may have only a handful of choices. If you own a jet warbird, you may only have two or three options, unless you use other collateral. Many lenders wont finance ag airplanes, antiques, helicopters or experimentals.
Of the lenders whom we spoke with, Greentree finances a greater variety than any other. About the only things that fly that they wont lend money for are ultralights and powered parachutes. Greentree also specializes in kit airplanes with track records and has an association program with EAA.
In some cases, the size of your loan will determine the bank you need to use. Randy Aarestad is the president of Red River Bank and also its one-man aircraft department. He told us that he specializes in smaller loans, often for people who are buying their first airplane.
Another factor may be your credit history. If you have had a recent bankruptcy, an equity lender like Joda Partnership or your platinum Visa card may be the only games in town. But dont give up. While most of the standard lenders are set up to take A credits internally, some will seek to place your loan elsewhere.
Once you have done this initial research, make a short list of people who probably can help you, and who you would like to work with. Then get your paperwork together. Here are some basic checklist items:
Make sure that the loan does not have a prepayment penalty clause. If you need to sell or refinance the airplane before the loan is up, this will cost you money.
Is there a large origination fee? Other than the equity lenders, who charge as much as 3 percent, most aircraft lenders charge modest fees, primarily to cover the cost of FAA filings, title searches, appraisals and the like. In many cases, the lender will charge you nothing if you arent approved for the loan. If you do agree to pay an up-front fee, make certain its in return for a lower rate and that youre likely to have the airplane long enough to get your money back.
Verify that the loan is a simple interest loan, without excessive up-front interest loading. Most ordinary loans involve more interest initially, but make sure youre not paying more than standard for loans of this type.
Are you dealing with a bank, an originator or a broker? Know that before signing.
If the airplane youre buying is a temporary stop on your way to something that can jump higher and run faster, consider a blended-rate with a longer period that delays its coupling to the prime rate. Five years will work for most buyers. Youll save on the rate and youll pay off more of the airplane by the time you trade.
In general, though, we favor the security of the fixed rate, especially when you consider that the additional cost is almost nil. Not so long ago, the prime was 18 percent. Were hearing noise that the Fed will lower interest rates another point in the upcoming year and that rates will stay there for some time.
We sure hope theyre right, but at some point, rates are going to rise again and credit will tighten. If youre going to own the airplane for a long time (some of us do), a fixed-rate loan with a term longer than your own scheduled payoff works best.
Get a 10-year note, pay it off in five. If thats too steep, get a 15-year year note and pay it off in 10. Youll have some cushion built in, in case you cant make the full payment.
But if youre thinking about buying new or upgrading, theres never been a better time to borrow money for an airplane. Rates havent been this low in years and there are a record number of lenders out there hoping to make you a deal you cant refuse.
-by Jon Doolittle
Jon Doolittle owns Sutton James Insurance in Hartford. Hes an Aviation Consumer contibuting editor.