Clients, in their purchase of higher value items such as homes or collectibles, may use loans as a means of financing. Private bankers can arrange for such loans, and can often provide favourable rates pending on the relationship between the client and the bank, the amount of business the client has done with the bank and the wealth/status of the individual.
What is a loan?
A loan is essentially a sum of money borrowed (by the debtor – the person that owes the debt) to be repaid to the lender with interest after a specific period of time.
Principal: This is the amount borrowed, and the amount to be paid back in full.
Interest: This is the amount on top of the principal to be given to the lender. Interest rates are expressed as a percentage of the principal. For example, a loan of $10,000 with an interest rate of 8% equates to $800 of interest payable
Types of Loans
These are loans for students to cover the cost of their education. Fees can be very costly, especially for higher education, and students (and their families) may not have the cash immediately available.
These loans, broadly speaking, are used for any personal expense and do not have a designated purpose. The interest rates on such loans depends greatly on one’s credit history and ability to repay – this analysis will be undertaken by the creditor (the lender)
These are loans provided for entrepreneurs to help them with their business birthing or expansion. Due to the generally high risk associated with businesses, rates on such loans tend to be high – particularly in the early stages of the business where profitability is in question.
Friends & Family
As implied, loans from friends and family are of a informal nature. While they may interest-free, the inability to repay such loans may strain relationships.
Cars are considered expensive items, with full upfront payment typically placing a big squeeze on an individual’s cash balance. Auto loans can help individuals pay for a car, and is usually broken down into monthly repayments (with interest) that an individual can cover (with his monthly salary).
Even more expensive than cars are homes, and mortgages are loans distributed (by banks) to allow individuals to buy homes they would not be able to pay for upfront. Mortgages use the homes as collateral, resulting in home foreclosure if the borrower cannot meet payment schedules. Due to the collateral behind mortgage loans, interest rates on mortgages tend to be low.
Home Equity Loans
These are loans using the equity one has built in his/her home (by paying back mortgages) as collateral. Due to the collateral, interest rates on such loans are lower compared to that of, for example, credit card loans which have no collateral. However, one must be aware of such leverage, given that a claim on one’s home as collateral could effectively render one homeless.
Why HNWIs need loans?
Given that HNWIs have a high net worth, it might seem counterintuitive for them to take up a loan following the logic – “Why not pay upfront in cash if cash is available?”. Simply put, HNWIs are often provided opportunities to make large-scale investments and/or costly purchases that would not be available if not for their net worth. Funding such purchases – for instance; the purchase of a building or an expensive piece of land – may put a squeeze on the cash balance of HNWI clients despite their high net worth to the extent that a loan, covered monthly by their high monthly income, may be sensible. In funding investments, it may also make sense to take up a loan when the yield on the investment is higher than the interest payment on the loan required to fund the investment. The HNWI, in such a scenario, is essentially earning a spread between yield and interest. This could happen in the privatisation of public companies or borrowing money to purchase a building from which rent can be collected.