How to read a loan term sheet

A term sheet is the first time a lender puts its intentions in writing. It is short, it is usually not binding, and it shapes almost everything that follows. Borrowers tend to read the rate and the loan amount and skim the rest. The rest is where most of the surprises at closing come from. Reading it carefully, line by line, is the cheapest diligence you will do on any financing.

Start with what the lender is actually offering

The headline terms describe the loan itself. Read each one as a condition, not a promise.

• Loan amount. Check whether it is a fixed number or "the lesser of" a dollar figure, a loan to value test, and a debt service coverage test. The lesser of language means the final amount can shrink after the appraisal and underwriting.
• Rate. Confirm whether it is fixed or floating, what index it is tied to, and when it is set. A rate quoted today may not be locked until closing.
• Term and amortization. The term is when the loan comes due. Amortization is how fast principal is repaid. A long amortization with a short term leaves a balance to refinance at maturity.
• Interest only period. Note how long it lasts and whether it depends on hitting a performance test.

Read the fees and the exit costs together

Fees are easy to miss because they sit in different paragraphs. Add them up in one place.

• Origination or commitment fees, and when they are earned.
• A good faith deposit, and whether it is refundable if the lender changes terms.
• Third party costs such as appraisal, environmental, legal, and title. Borrowers typically pay these whether or not the loan closes.
• Exit fees and prepayment terms. A step down schedule, yield maintenance, or defeasance can change the cost of selling or refinancing early. Our article on prepayment penalties covers how each one works.

The useful question is simple. What does this loan cost if everything goes to plan, and what does it cost if you need to exit in year two?

Look closely at guarantees and covenants

This is the section that governs the relationship after closing.

Recourse and carve outs

Find out who signs a guarantee and what it covers. A loan described as non recourse still carries carve outs for specific acts, and some term sheets add partial recourse or completion guarantees. Our piece on recourse and non recourse loans explains the distinction.

Ongoing tests

Covenants are the promises you keep for the life of the loan. Common ones include minimum debt service coverage, minimum liquidity and net worth for the guarantor, and reporting deadlines. Ask how each is measured, how often it is tested, and what happens on a miss. A cash sweep or a required paydown is very different from a technical default.

Reserves

Lenders may require reserves for taxes, insurance, replacement items, tenant improvements, or leasing costs. Reserves reduce the cash you actually receive at closing. Factor them into your sources and uses.

Know what is binding and what is not

Most term sheets state that they are not a commitment. That cuts both ways. The lender can change terms after diligence. You may still owe the deposit and third party costs. Read the language on:

• Conditions to closing, including credit approval and satisfactory diligence.
• Expiration dates for the term sheet and for any rate lock.
• Exclusivity, which can stop you from talking to other lenders for a period.
• Any "material adverse change" clause that lets the lender walk away.

Compare offers on the same basis

When you have more than one term sheet, lay them side by side. Normalize the loan amount after all sizing tests, the total fees, the reserves, the recourse, and the prepayment cost under a realistic hold period. The lowest rate is not always the cheapest loan, and the largest proceeds are not always available at closing. Ask each lender to clarify anything vague before you sign. Clarity is easier to get before a deposit changes hands.

Before you sign, test how the loan sizes against your own numbers with our debt sizing tool. If you would like a second read on a term sheet, or help sourcing alternatives, contact us.