- 26 Mar 2020
- René Armas Maes
- Finance - BizAv
In today’s environment of low interest rates, borrowing to finance a business jet acquisition could be attractive for businesses and wealthy individuals. There are several factors to bear in mind, though, according to industry experts. Gerard Cowan explores.
Borrowing money to finance a business aircraft acquisition can be an attractive proposition to many. But what's the real cost, and what should borrowers take into account to ensure it's right for them?
There are numerous ways to fund an aircraft today beyond traditional loans, according to Greg Holst, aircraft division president emeritus, 1st Source Bank (a US aircraft financing specialist). These include various types of leases or fractional ownership. Other buyers acquire their aircraft with cash.
But despite the expansion of options, a significant proportion of buyers still opt for more traditional loan financing, where they borrow against their ownership of the aircraft as collateral, Holst notes.
Tax benefits can play a role here, with aircraft owners in the US able to reduce their tax payments through ‘Bonus Depreciation’ rules in many cases, effectively deducting much of the initial cost of the aircraft.
When Does Borrowing Make Sense?
Finance-savvy companies and individuals can use debt to their business advantage, says Adam Meredith, president of AOPA Finance (a finance broker that focuses on aviation). In today’s environment of extremely low interest rates, aircraft owners might decide that borrowing makes more sense than using cash, allowing them to use their money to generate higher returns in their business.
For example, if a loan costs 3% or less in annual interest payments, but the borrower makes an annual rate of return of 10% or more on their business, it makes sense to free up the cash to invest in their own endeavours, Meredith says.
Ownership of an aircraft – whether through cash or borrowing – can generate returns in its own right, Holst adds.
Chief executives and other senior personnel have a finite amount of time to see clients and do business, so “an aircraft is the closest thing we have to a time machine in terms of taking that resource, which we can’t duplicate or expand, finding ways to get more done in the hours we have each day”.
What Factors Affect the Terms of a Loan?
Of course, the terms of a financing loan can differ from one borrower to another. AOPA highlights five major areas for borrowers to bear in mind that can affect the terms offered. These include:
1) Usage: A financing company wants to know that an aircraft acquisition is appropriate to the owner’s needs, and how it will be used. The more an airplane is used, the more it depreciates, and the more wear and tear it suffers. As the lender is effectively the aircraft’s co-owner, it’s important that their asset retains its value well.
2) Age, Make & Model: The older an airplane, the fewer the financing options. Lenders will also consider the condition of the aircraft’s onboard equipment (notably its avionics).
3) History: Borrowers must know all the specifications of their airplane, be able to supply photos, and show its maintenance and damage history (if any).
4) Down Payment: This is required and will commonly be between 15-20%. In general the, higher the down payment, the longer the term of the loan, depending on the borrower’s wishes.
5) Loan Amount: The borrower should think about the amount they want to borrow. For smaller amounts, buyers should be aware that the loan typically will require larger deposits and shorter payment terms, as well as demanding a higher interest rate. On the other hand, the higher the amount borrowed, the more options become available.
Meredith suggests borrowers consider securing pre-approval on a loan before bidding. “The market for in-demand models is incredibly hot right now,” he says. “Sellers know this, and they’re going to favour an offer from somebody who’s at least pre-approved to purchase something, much like when you’re purchasing a home.”
How to Succeed with an Aircraft Finance Lender
Holst says the key to success with a lender is ensuring “they fully understand your success as a businessperson”. That means it is essential to provide between three and five years of financial history.
Given the typical size of aircraft loans, these statements should be audited or reviewed by an external, Certified Public Accountant (CPA) whenever practical.
“That makes the numbers more reliable and trustworthy for a bank,” Holst explains, adding that it also may be worthwhile consulting with lawyers and other technical experts with aviation expertise to ensure compliance with US federal regulations and avoid other surprises at or post-closing.
Safeguarding Against Surprises
When considering finance terms, borrowers must insist on simplicity, says Vivek Kaushal, president and COO, Global Jet Capital, which provides a range of leasing and lending solutions in Business Aviation.
They must be able to determine the total cost of their financing at a glance, confirming there are no additional fees that the provider intends to charge. Additionally, if the financing is indexed to a benchmark rate – like the London Inter-Bank Offered Rate (LIBOR) – a change in those rates could also affect the financing cost.
“Most importantly, retain experienced tax advisors, as different types of financing can have differing tax implications,” Kaushal adds.
If a borrower works with an experienced and trusted provider, there should not be unexpected changes to financing costs along the way, he says. However, it’s best to stay in close touch with the financing provider to keep abreast of any new developments.
Holst points to a number of “eleventh hour glitches” he’s seen, though he notes that these would probably be avoided through thorough preparation. For example, if an aircraft has not been properly inspected ahead of buying, there could end up being future maintenance costs that were not factored in to the original loan arrangement.
Additionally, insurance is not always a given, he notes. While it should be a relatively easy process, particularly for those who’ve already owned aircraft, new owners are finding insurance coverage more difficult and costly to acquire, particularly for owner/pilots. This could add unexpected costs.
“This is where an aircraft expert, someone who's been loaning money on aircraft and does it as a specialty, should be able to help guide you and give you some support,” Holst concludes.