What Are Loan Proceeds? Definition, 9 Facts & Example

Are you interested in knowing what are loan proceeds or even what are the different types of loans? Then, keep reading this article for a quick understanding on the topic.

What Are Loan Proceeds?

Loan proceeds are the money disbursed from a loan, less any associated fees. This article will focus on the income generated by commercial real estate (“CRE”) loans. However, concerns regarding loan revenues are applicable to all types of loans. Typically, borrowers receive CRE loan funds at the completion of a loan transaction or shortly thereafter.

Typically, lenders send the funds to the borrower directly or to a third party. In particular, the third party uses the cash for a variety of purposes. The loan agreement defines the loan amount, interest rate, and repayment conditions. In some instances, a loan may include a prepayment penalty that discourages early debt repayment.

Fees and Expenses

The loan agreement contains every detail regarding the loan. These fees and costs cover the cost of loan preparation and extension.

1. Origination Fee

This is the cost charged by lenders for initiating a loan. A typical origination fee ranges from 0.5 percent to 5 percent of the entire loan amount, depending on the kind of loan and the type of lender providing funding. Consider, for example, a $10 million loan with a 1% origination cost.

The lender will deduct $100,000 to satisfy the origination charge from the loan proceeds. Typically, lenders explain the price charged for initial loan application processing and underwriting.

In truth, a portion of the charge represents the lender’s pure profit. Origination costs are sometimes referred to as points or discount fees, particularly when the fee is a whole point value, such as 1 percent or 2 percent.

In exchange for their business, borrowers might attempt to minimize the origination costs they are charged. Obviously, this strategy is superior if the borrower has many offers.

What Are Loan Proceeds? 

However, borrowers must be realistic and recognize that lenders do not labor for free. Alternatively, smaller loans may have a higher origination charge to meet the lender’s fixed costs.

Borrowers should not realistically expect lenders to labor for free. In general, it may be advantageous for borrowers to pay a greater origination cost in return for a lower interest rate. This is especially true for long-term loans, when the interest savings may exceed the origination charge. The amount of the origination charge should never be a surprise at the closing.

2. Underwriting Fee

This charge covers the lender’s costs associated with underwriting a loan. Underwriting is the procedure through which the lender evaluates the borrower’s creditworthiness. In particular, the underwriters need evidence that the borrower will return the loan on time and in full. The charge amount is determined by:

The borrower’s credit history

The loan type

The loan size

The lender’s loan program

3. Title Insurance

The responsibility of the title agent is to ensure that the borrower has a clear title to the property. This protects the borrower in the event that the title’s legitimacy is contested. It safeguards the title insurance holder(s) from liabilities resulting from inadequate title or lien searches.

4. Real Estate Taxes

If you are purchasing a home, you may be required to pay prorated property taxes at the closing. Specifically, you must pay your proportional share of property taxes so the seller may receive credit for its payments.

What Are Loan Proceeds? 

The seller may be entitled to a refund of the previously paid real estate taxes. This occurs naturally when the vendor has paid taxes in advance for the entire term. The seller pays taxes for the time leading up to the closing date and receives a refund for the remainder.

5. Commercial Property Insurance

This insurance safeguards both the lender and the borrower against property damage. Obviously, the price for a loan broker’s services is dependent on the following factors:

The value of the property

The loan amount

The property location

Any specific risk factors

6. Broker Fees

It might be a fixed cost, a percentage of each transaction, or a combination of the two (though this is exceedingly uncommon). However, it is nearly usually expressed as a percentage of the loan amount.

7. Lender’s Legal Fee

Occasionally, the lender requires the borrower to pay usual legal fees associated with the funding transaction. Legal fees are influenced by the amount of the loan and/or the loan and/or property specifics.

What Are Loan Proceeds? 

8. Other Closing Fees

These would include any additional closing costs charged by the lender. Specifically, the kind of lender and the location of the closure are variables in these expenses.

How to Calculate Loan Proceeds

The formula for determining net loan proceeds is as follows:

Loan Amount minus Closing Costs = Loan Proceeds

Expect closing expenses to vary between 3 and 10 percent for basic and complicated refinancings, respectively. Typically, a neutral third party, such as an escrow agency, would distribute money to various parties and monitor the closure.

Example Calculation

Suppose you acquire a 10-million-dollar apartment complex. In addition, the total closing fees are $460,000. Therefore, the loan proceeds equal $9,540,000 after deducting $460,000. Consequently, you get a cashier’s check in this amount from the lender via the escrow agency handling the closing.

You can also request the lender to transfer the funds straight into your bank account. The lender’s payment may take several days to clear the bank.

Use of Loan Proceeds

The loan agreement may stipulate restrictions on the borrower’s use of the loan funds. Indeed, government-backed loans may be subject to stringent restrictions.

On the other hand, you are occasionally free to utilize the loan funds as you see proper. For instance, you may refinance a property to extract equity.

You may freely spend the cash-out part. For instance, you may utilize the money to finance other transactions, restructure debt, or acquire a boat.

What is a loan proceeds check?

This is the check that the bank or other lender issues to the borrower for the loan proceeds. The check qualifies as a cashier’s check or teller’s check under the unified commercial code (UCC). Therefore, it is subject to all UCC requirements pertaining to checks of this nature.

What Are Loan Proceeds? 

Are loan proceeds taxable for a trust?

This is the check that the bank or other lender issues to the borrower for the loan proceeds. The check qualifies as a cashier’s check or teller’s check under the unified commercial code (UCC). Therefore, it is subject to all UCC requirements pertaining to checks of this nature.

How do I book loan proceeds that I haven’t yet received?

Upon closing, you typically credit a liability, such as accounts payable, and debit an asset. Specifically, the credit is for the entire loaned amount, not just the revenues. The difference between the loan amount and revenues is recorded as a cost or expenses.

Until you get the cash, record them as “loan proceeds receivable” on your balance sheet. Once disbursement has been received, credit the receivables account and debit cash.

What is the best use of proceeds from a high-risk loan for the lender to approve?

Typically, the optimal use of earnings is to first pay off any outstanding loans. The wisest use of the cash would then be for a specified purpose. Obviously, this application relies on the type of the loan. For instance, it may be to fund the acquisition or building of commercial real estate.

What Are Loan Proceeds? 

Conclusion

The loan proceeds are the monies released by the lender after deducting any origination and processing costs. These monies may be paid directly to the borrower or to a third party who is allowed to take custody of the funds and apply them to the borrower’s costs.

Under the terms of the loan agreement, borrowers are required to repay the loan on the agreed-upon timetable, such as 30 years for a mortgage. Depending on the type of loan, they may be eligible for incentives such as discounted interest or early repayment without penalties.

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Pat Moriarty
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