by Charles H. Major

by Charles H. Major

In 1989, I was faced with the prospect of major surgery to my spinal column. A mistake
could leave me paralyzed. The most significant decision was not whether to operate, but
rather who would perform the surgery. Trusting in God, I concluded that my choice of
surgeon would determine more than any other single factor, the ultimate success of my
operation. What, you may be asking yourself, does this have to do with church finance?

The Right Choice

A church is a unique entity: an organized body of Christ charged with doing God’s work
in the corporate sense. All of a church’s decisions should be made from a spiritual
perspective, and its financial decisions should be no exception. A church’s cash flow–the
result of tithes and offerings received and expenditures made to support the
ministry–must be understood both from a numerical perspective and within the context of
ministry needs. When those needs require finance, the provider of the funds should be
someone who can best understand the totality of the church and provide financing that will
enhance the ministry.

Like my surgery, the success of a church’s financing depends on the skills and
experience of the person or entity chosen to analyze options and recommend a specific
financing method that will meet both the financial and ministry needs of the church.
Traditionally, there have been several types of firms that a church could turn to as
providers of the various forms of funding. Among these are banks, bond companies, fund
raisers and investment bankers that specialize in church finance. The possible sources of
funds to meet a need include pledges from members, loans from members, traditional bank
loans and bonds.

When I chose my surgeon, I wanted someone who could diagnose my need, recommend the
proper treatment and perform the operation. Likewise, a church needs someone who can not
only provide funding, but also recommend what is best for the church and its ministry. RSI
Financial Services, as an investment banker, considers its role to be that of a
“financial architect,” and we facilitate a process that ultimately leads to the
financing of the specified project. This process includes a financial analysis necessary
to design and bring to the church the most cost-effective financing available.

Consider for a moment the possible sources of funds and the advantages of each. The
most cost-effective approach is the “gifting” of money to fund a project. A
church can retain outside counsel to design and implement a capital campaign to fund the
need. This approach results in funds being available for the project that do not have to
be repaid; hence, most or all of the church’s future tithes and offerings are available
for ministry rather than for funding the project.

The church always should give serious consideration to this source of funds first.
However, even with a successful capital campaign, more often than not, some measure of
additional funding is required and borrowing becomes necessary.

In cases where borrowing is necessary to fund immediate needs, the question is not,
“How much can we borrow?” but rather, “How much can we afford to
repay?” This step in the process is most crucial, as the commitment to future debt
service will have significant impact on a church’s ability to fund its ongoing ministry.

The answer to the second question also will be a factor in determining the most
appropriate debt instrument. The level of funds available for debt service influences the
term of repayment. The exposure to debt must take into account future growth, future need
and anticipated economic conditions.

There are industry guidelines used by financial and lending organizations to help a
church determine how much debt is appropriate. Several key factors that are given the most
weight from a lender’s perspective are:

  • Total debt to income ratio.
  • Debt service to income ratio.
  • Debt to collateral value.
  • Cash flow.

The total debt never should exceed four times the church’s annual income, and keeping
this ratio to three times or below is much more desirable. Often times, the church must
build its project in phases to satisfy this condition. The ratio of monthly debt service
to monthly income should remain below 35 percent. There always is a correlation between
the size of a church’s membership, its per capita giving and the members’ expectations for
ministry and programs. When debt service is out of proportion to regular monthly giving of
members, the church is not able to meet ministry needs. Finally, because lenders are
concerned with collateral underlying the debt, the value of the property used to secure
the loan should be at least one-third higher than the debt.

All of these ratios are guidelines, and each project is evaluated in light of all
factors impacting the church, including support for the project, members’ stewardship
commitment, membership and community growth, membership age distribution and population
demographics. At this stage of the process, many financial institutions can help a church
understand what it reasonably can expect to borrow. With an increasing understanding on
the part of church leadership of what is needed and what the church can afford, a church
can have a reasonable idea of the amount of dollars that its project can absorb. Armed
with this information, the church finally is ready to examine its financing options.

Plans For Action

Knowing the project cost and the amount of debt service available from the church
budget, the time frame for debt retirement can be estimated. Short and long-term financing
carry completely different considerations. The two most significant determinants are the
cost of money and the volatility of rates. If it has been determined during the process
previously discussed that the amortization of the debt can occur in a short period of
time, the weight of the decision falls on the cost of money as well as current interest
rates, and closing costs move to the forefront. On the other hand, if debt service is
projected to require longer than five to seven years to amortize, interest rate volatility
should become an influencing factor.

Traditional bank financing generally is most appropriate for short-term amortization
periods. The interest rates can be set for the duration of the loan. As the length of the
amortization increases, bonds become more attractive as interest rates can be fixed for
the entire issue period. Keep in mind that an amortization period is the length of time
during which the principal is to be fully repaid. With a bank loan, a church can have a
short-term note with a long-term amortization, thereby creating a situation where the loan
may be extended with new interest rate considerations. As experienced over the past
several decades, the ministry can be put at risk if interest rate volatility returns to
the financial markets.

The initial and long-term cost of the financing is always a consideration. Leadership
must look at all costs associated with the issuance of debt. Many costs for both bank and
bond financing are similar. Total closing costs associated with bond financing almost
always are higher than those associated with a bank loan; however, interim interest costs
associated with construction financing must be taken into account for a fair comparison.
Any premium cost associated with bonds must be viewed in light of the potentially higher
interest costs as a result of future interest rate changes. Ultimately, the analysis must
calculate the total cost of the finance option, including up-front fees, points, closing
costs, prepayment penalties, refinance costs and interest.

Where Do We Go Now?

With all of these considerations, where does church leadership turn and whom do they
rely upon? When I was looking for a surgeon, I wanted skills and specific experience. Ask
a prospective lender to describe their past experience in church lending. Learn how many
church loans they have made or arranged. Do they have any expertise in helping determine
the appropriateness of your project? How many loans have they taken to full maturity under
the initial terms and conditions? Have there been any defaults by their borrowers, and, if
so, how did they deal with those situations? Do they add value to the process or just
provide money?

Before you begin your project, seek to find an investment banking firm that has access
to multiple sources of funding-bank loans, bond issues and capital stewardship programs.
Church leaders should look for a finance company with the capability to conduct a needs
analysis as well as design and implement a cost-effective financing package that will have
a positive effect on the health and vitality of a church’s ministry for years to come.

By the way, my surgery was successful.

A Few, Easy Steps:
Applying For A Church Loan

The following illustrates some of the criteria necessary for initiating the loan

Step One: In order to make the process run more efficiently, churches
should gather at least three years of financial statements detailing if their cash flow
will cover the anticipated debt service on the requested loan. With these statements,
churches should be prepared to provide a detailed church history, attendance figures and
the reason for their loan request. Be aware that all special contributions and
fund-raising activities are listed separately. Remember, having more information is better
than not enough. Do not be afraid of listing too many details in reference to your loan

Step Two: Church administrators should acquire an appraisal of the
church and all of its properties. In most instances, a short form appraisal will be
suitable for an initial loan review. Keep in mind that in addition to total debt to income
ratio, the loan to value ratio will be an important factor in determining a church’s
ability to finance a loan. A proper appraisal balanced against the church’s accounting
records will help determine if the church is prepared to handle a bank loan. On average,
the ratio of the requested loan should not exceed 70 percent of the appraised value of the
church properties.

Step Three: Using all the aforementioned data, including the appraisal
form, churches then should complete a loan application for their desired lender.

Step Four: When meeting with the prospective lender, churches should
address any and all financing concerns, including any special or unusual conditions
concerning the loan request.

Charles H. Major is president of RSI Financial Services Inc. based in Dallas,
Texas. RSI provides biblically-based, consultant-led stewardship programs for more than
3,400 churches nationwide.