"What’s the interest rate?" is the most common question I get when I am speaking to charities about social investment opportunities. When I reply that rates of between 6 and 12 per cent are common, the default reaction is usually for people to widen their eyes and say "I could get it for much less than that at Barclays".
I firmly believe that it is the role of social investors to make loans available for charities and social enterprises as cheaply as possible. But when shopping around it is useful to think about which comparisons are most appropriate, and headline interest rates are not the only considerations when judging whether a particular investment is right for you.
Let’s start with that comparison with mainstream banks. Charities have been borrowing from banks for decades, usually for mortgages, or at least with some form of security in case the borrower is unable to repay. If you are looking for a secured loan for an asset, a bank is certainly a good place to start. But if you don’t have security to offer and are looking for a loan for other things, such as to fund general growth, then a bank is less likely to lend to you because the risks of not getting their money back are greater. Higher risk equates to higher cost, so unsecured lending is likely to cost more than a mortgage.
That’s where specialist social investment providers are best placed to help. Much more finance has been made available over the past few years to support unsecured borrowing by charities and social enterprises.
So what should you be thinking about when comparing loans out there in the market?
First, the most important consideration in taking out a loan is affordability. Based on your income, how much can you comfortably afford to pay back each month? The interest rate is only one factor in this. Your monthly payments will be a mixture of repayment of the loan itself and the interest. The interest will usually be a small part of this, so the period over which the loan is repaid is more important than the interest rate to the size of your monthly payments.
For example, if you borrow £50,000 over three years at 8 per cent you will pay £1,567 each month. If the loan is over five years, the monthly payments are £1,014.
For relatively short loans, a difference in the headline interest rate will have a fairly marginal impact on the monthly payments. For £50,000 over three years, the difference between repayments at 6 per cent and 8 per cent is £46 a month.
Second, when comparing headline interest rates you need to understand how they are calculated, for there is more than one way. For example, the interest might be on a declining balance rate, which means that as the outstanding debt reduces so does the amount of interest. Or it could be on the more expensive fixed-flat basis, which means that the interest is calculated as a proportion of the total amount borrowed and that amount of interest is added to each month’s payments. Also be aware of any fees for arranging or monitoring the loan, which might be rolled up into the repayments. Ask for the annual equivalent rate in order to get a clearer picture.
Another factor to consider when assessing affordability is whether there is any flexibility in repayments. The best example of this is a repayment holiday built into the loan to allow for the time it takes for new income to be generated. This can make a big difference to affordability and most social investors are prepared to consider it as an option.
Finally, the evidence from charities and social enterprises suggests that price is only one of many factors that influence any decision to take a loans from a particular investor. Recent research by the Institute for Voluntary Action Research, which looked at small charities and social investment, highlighted the importance of an alignment of mission and establishing long-term relationships with investors. For some this is more important that securing the lowest possible price.
Seb Elsworth is the chief executive of Access, a foundation that helps charities and social enterprises access social investment