What Is a Take-Out Loan?
A take-out loan is a type of long-term financing that replaces short-term interim financing. Such loans are usually mortgages with fixed payments that are amortizing. Institutions that issue take-out loans are normally large financial conglomerates, such as insurance or investment companies, while banks or savings and loan companies usually issue short-term loans, such as a construction loan.
How a Take-Out Loan Works
A borrower must complete a full credit application to obtain approval for a take-out loan, which is used to replace a previous loan, often one with a shorter duration and higher interest rate. All types of borrowers can get a take-out loan from a credit issuer to pay off past debts. Take-out loans can be used as a long-term personal loan to pay off previous outstanding balances with other creditors. They are most commonly used in real estate construction to help a borrower replace a short-term construction loan and obtain more-favorable financing terms. The take-out loan's terms can include monthly payments or a one-time balloon payment at maturity.
[Important: Take-out loans are an important way of stabilizing your financing by replacing a short-term, higher-interest-rate loan with a long-term, lower-interest-rate one.]
How Do Businesses Use Take-Out Loans?
Construction projects on all types of real estate property require a high initial investment, yet they are not backed by a fully complete piece of property. Therefore, construction companies typically must obtain high-interest short-term loans to complete the initial phases of property development. Construction companies may choose to obtain a delayed draw term loan, which can be based on various construction milestones being met before principal balances are dispersed. They also have the option of obtaining a short-term loan. Many short-term loans will provide the borrower with a principal payout that requires payment at a future time. Often the borrowing terms allow the borrower to make a one-time payoff at the loan’s maturity. This provides an optimal opportunity for a borrower to obtain a take-out loan with more-favorable terms.
Example of a Take-Out Loan
Assume XYZ company has received approval for plans to build a commercial real estate office building over 12 to 18 months. It may obtain a short-term loan for the financing it needs to build the property, with full repayment required in 18 months. The property plans are achieved ahead of schedule and the building is completed in 12 months. XYZ now has more negotiating power, because the fully complete property is able to be used as collateral. Thus, it decides to obtain a take-out loan, which provides it with the principal to pay off the previous loan six months early.
The new loan allows XYZ to make monthly payments over 15 years at an interest rate that is half of that of the short-term loan. With the take-out loan, it can repay its short-term loan six months early, saving on interest costs. XYZ now has 15 years to pay its new take-out loan at a much lower rate of interest, using the completed property as collateral.