What Is a Fully Drawn Advance?
A fully drawn advance is a type of loan used in Australia. Although they can be customized to suit various needs, fully drawn advances are commonly used as long-term business loans.
- A fully drawn advance is a type of long-term loan that is popular in Australia.
- They are known for their highly customizable loan terms.
- Fully drawn advances are essentially term loans which can be structured either as secured or unsecured loans.
Understanding Fully Drawn Advances
A fully drawn advance is essentially a term loan in which the borrower receives the principal upon initiation of the loan and agrees to repay the principal with interest according to a predetermined amortization schedule. The details of the fully drawn advance, such as whether fixed or variable interest is used, can differ depending on the lender's needs.
Fully drawn advances are generally structured as long-term loans, which makes them well suited for financing the purchase of assets with long useful lives, such as real estate or long-lived equipment. Fully drawn advances can be structured as secured loans, in which the underlying asset is pledged as collateral, or as unsecured loans.
Further customization is available in regard to the timing of interest payments. Interest can be fixed or variable, and it can be charged monthly, quarterly, semiannually, or even once per year. Fully drawn advances can even be structured as interest-only loans, in which the principal is repaid in a single balloon payment at the end of the term.
One advantage of using a fixed interest rate is that the payments are stable and predictable throughout the term of the loan. On the other hand, choosing a fixed rate exposes the borrower to the risk that market interest rates might decline during the life of the loan. In this scenario, the borrower will suffer from the opportunity cost of paying an above-market interest rate. And while it may be possible to refinance the loan in order to take advantage of the lower rates, doing so may trigger prepayment penalties.
Variable interest rates, on the other hand, will rise or fall depending on the broader financial markets. This makes it difficult for the borrower to accurately forecast the true cost of the loan over time. On the other hand, the fully drawn advance might include provisions for maximum interest rates, which can help the borrower understand and prepare for the potential cost of holding the loan if interest rates rise during the loan term.
Real-World Example of a Fully Drawn Advance
Al is the owner of a small business based in Australia. He wishes to purchase new equipment to allow his business to expand its production. To that end, Al approaches his account manager at XYZ Bank to discuss taking out a fully drawn advance.
Al's account manager explains that the terms of the fully drawn advance can be customized to suit his needs. In this instance, Al is seeking to buy equipment with a likely useful life of 20 years. He estimates that it will take 12 months before the equipment is up and running and able to generate revenues for his business.
In hearing his priorities, Al's account manager recommends structuring a fully drawn advance with a 20-year amortization, in which the loan is interest-only for the first 12 months. This way, Al will be able to minimize his loan payments until his equipment is able to contribute revenue toward the payment of its loan. To further minimize the uncertainty of the loan, he recommends using a fixed interest rate so that Al can plan for his loan payments with a high level of accuracy.