How Does a Nonprofit Loan for Nonprofit Organizations Work?

Structure

Nonprofit Organizations that are looking for a Nonprofit Loan or a Nonprofit Line of Credit have a few directions they can go. A Nonprofit Loan is a fixed amount of money that is borrowed and paid back overtime.  A Nonprofit Line of Credit is an agreed upon amount of money that your nonprofit has access to whenever cashflow is down. In the past, nonprofits had been unable to get any type of nonprofit loan but that has changed due to companies like Financing Solutions which has created a Line of Credit specifically for Nonprofits.  

A Loan

You’re probably already familiar with a loan as it is the most common form of lending from commercial or local banks like Citibank, Wells Fargo and others. With a loan, a lender provides a borrower with a fixed sum of money at the outset. The money must be repaid, with interest, on a fixed schedule that often lasts one, three, or five years. In the case of mortgages, a specially regulated category of loans, the term can be as long as thirty years.

A Line of Credit

In a line of credit with a commercial bank, a fixed amount of credit is extended by the lender to the borrower. The borrower is free to use as much of this line of credit as they wish and pays interest only on the outstanding amount on the line of credit. The borrower is typically only responsible for satisfying the interest payments on the outstanding amount each month and can carry the principal amount of debt for as long as the credit line remains open.

A credit line has several advantages. It is flexible as the borrower is free to borrow as little or as much as they wish, up to the credit limit. It is typically less expensive, too, as the borrower pays interest only on the outstanding amount.

Risk

The interest rate on a loan or credit line is typically calculated based on the risk of the lender not being able to recover the principal from the borrower. This situation is called default. To calculate the risk of default, the lender usually examines the financial statements (or in the case of a nonprofit their 990) of the borrowing company, considers the industry that the borrower is in, looks at the credit ratings of the company and its representatives, and takes into account any other factors that might be relevant in determining the credit-worthiness of the company.

This task is slightly more complicated in the case of a nonprofit. By definition, nonprofits do not earn profits for the sake of profit so lenders must look to factors other than the nonprofit’s ability to earn money to determine credit-worthiness.

Frequently, these other factors include the nonprofit’s plan for paying back the principal with interest in the case a loan or for servicing the interest payments for a line of credit. If the nonprofit has a strong and consistent cash flow along with a robust financial plan that accommodates the additional expenses that accompany a loan or line of credit, a lender is much more likely to lend to the non-profit.

Lastly, if the nonprofit’s reasons for borrowing are financially sound and make sense, the lender is more likely to lend to the nonprofit. For example, if a nonprofit is taking on a line of credit because of cash flow timing issues, like it earns revenue at the end of the month but its bills are due at the beginning of the month and it needs credit to cover the balance in the interim, but its financial fundamentals are sound, it is more likely to be approved. Or, if the nonprofit wishes to take on a large project that is highly likely to succeed and dramatically improve its ability to earn revenue but it requires capital to make this work, a lender is more likely to lend them money.

All of this should be contrasted with a nonprofit whose financials are fundamentally unsound and requires a loan because its expenses are consistently higher than its revenues. Such a company is unlikely to satisfy a lender that the risk of lending is warranted, regardless of the interest rate.

Considerations for the Nonprofit

Nonprofits should consider carefully whether they could benefit from either a loan or a line of credit. Let’s take a closer look.

Loans

Loans can be beneficial for nonprofits that find themselves in need of a large capital infusion for a fresh project. Loans can be especially useful in cases where a new project can potentially bring in large amounts of revenue but cannot be completed without the loan.

Of course, the nonprofit must have a plan for serving the loan after it has been accepted. All the additional revenue in the world won’t matter if the financials of the company don’t allow for the repayment of the interest and principal on the schedule set out by the lender.

Lines of Credit

Lines of credit can be beneficial for nonprofits who find themselves in need of some additional financial flexibility. Unlike loans, which are generally useful for large one-time expenses, lines of credit are great when a non-profit frequently or occasionally finds itself in need of additional cash or wishes to smooth out volatile increases and decreases in its cash balances. As with loans, a nonprofit has to have a solid plan for servicing the interest payments that arise from relying on lines of credit in lean times. After all, the purpose of a line of credit is to provide additional financial flexibility, not provide additional net cash.

Wrapping Up

To sum up, nonprofit lending works much the same way as lending to for-profit companies. The same principles are at play but the details are a bit different. Because of a nonprofit’s distinct risk profile, lending institutions consider other factors when deciding whether to lend to a nonprofit.

If you’re looking for some additional financial flexibility in your nonprofit, why not consider a line of credit from Financing Solutions? Financing Solutions is a leading provider of business loans for nonprofits in the form of a 501c3/not-for-profit line of credit. We offer a Nonprofit Line Of Credit that costs nothing to set up and nothing until used making it a great cash backup plan and when your Line of Credit is used it is inexpensive. Check us out today!