Small business executives, financiers and even bank employees often have questions about loan pricing. How are commercial loan interest rates determined? Pricing at what the competiton is doing does not get you to the profitability goals of the organization. Why do they fluctuate so often? And why does one institution provide a different rate than another on the same asset? In fact, many people might be surprised to know that the inputs to a commercial loan pricing model are quite logical and straightforward; but there are lot of different inputs so you can account for the many various factors that impact a specific loan situation.
The Hurdle Group provides an easy to use commercial loan pricing model called PULPS that is accessed online or via a customized on-premise model. There are several key inputs to this model. The most important input is the cost of funds. This dictates the lowest rate at which you would break even on the loan assuming no loss and no other administrative or service costs.
The next input is the risk factor which dictates the probability of the loan defaulting. The risk factor is expressed in many ways including similar loan default rates, correlation with other loans in your portfolio, the overall national economic data and the asset value.
Finally, the fixed administrative, origination and service fees that are associated with the loan are included as inputs into the model. These fees tend to have large impacts on the profitability over time if they are not managed properly.
Incorporating all of these inputs into our calculations, our model can provide an estimate of the profitability of the loan before it is issued.
To find out more about our proprietary commercial loan pricing model, please contact us. Our executives will walk you through the model and how it can help your organization.