When choosing a hard money loan, most investors focus on interest rates, loan terms, and funding speed. But there’s another factor that can significantly affect your return on investment: loan structure. Specifically, whether your loan uses a Dutch interest structure or not.
Dutch interest loans can offer fast access to capital, but they often come with hidden costs that many investors don’t realize until it’s too late. Understanding how these loans work and how they differ from non-Dutch structures can help you avoid overpaying and preserve your profit margins.
What Is a Dutch Interest Loan?
A Dutch interest loan charges the full amount of interest due at the time the loan is originated. The lender calculates interest on the entire loan amount and deducts it upfront or adds it to the balance. This means you’re effectively paying interest on money you haven’t used yet especially if the loan is structured to fund in draws over time (like for construction or renovations).
How It Works:
- If you’re approved for a $200,000 loan at 12% annual interest for 12 months, a Dutch loan may calculate the full $24,000 in interest at origination.
- That amount could be deducted from your loan proceeds or paid upfront even if you only use part of the funds or pay off early.
Interested in learning more about Dutch vs Non-Dutch loans? Check out our blog on Dutch vs Non-Dutch loans for a more in-depth explanation of what each loan means and an example of what you’ll end up paying.
The Hidden Cost of Paying for Unused Capital
The core issue with Dutch interest loans is simple: you may pay for money you never borrowed or never need for the full term. This has a few costly implications:
1. Interest on Unused Funds
If your project only requires $150,000 of the $200,000 loan, you’re still paying interest on the full amount. That $50,000 in unused capital? You’re still being charged as if you borrowed it.
2. No Benefit for Early Repayment
In most Dutch structures, even if you pay off the loan early, you don’t get interest back. You’re locked into the full interest expense, even if your actual loan term was half the length.
3. Profit Erosion
Especially in fix-and-flip deals, margins are tight. Paying for interest you didn’t use whether through early payoff penalties or unused draws can eat directly into your returns.
Dutch vs. Non-Dutch Loans: What’s the Difference?
Here’s how Dutch interest loans compare to standard, non-Dutch (or pay-as-you-go) structures:
Dutch Interest Loans:
- Interest is charged on the full loan amount at the start of the term
- You pay the full interest amount even if you use only part of the loan
- No interest refund if you repay early
- Can reduce flexibility in managing cash flow
Non-Dutch (Pay-As-You-Go) Loans:
- Interest is only charged on the amount of funds drawn
- You only pay for what you use, when you use it
- Early payoff can save you money by cutting interest accrual
- Offers better control over financing costs and exit strategies
How to Avoid the Pitfalls of Dutch Interest Loans
Dutch loans aren’t always bad, in some cases, like when you need the entire loan amount immediately and plan to hold the loan full term, a Dutch structure can work. However, most investors can benefit from more flexible terms.
Here’s how to avoid unnecessary interest costs:
1. Ask About Loan Structure Upfront
Before signing anything, ask if the loan is Dutch or non-Dutch. Make sure you understand how interest is calculated and when it accrues.
2. Compare Based on Usage, Not Just Rates
A lower rate on a Dutch loan may still cost more overall than a slightly higher rate on a non-Dutch structure especially if you’re paying interest on unused capital.
3. Choose a Lender That Offers Non-Dutch Options
At LJC Financial, we structure our loans based on how you use the capital. That means you only pay interest on funds drawn, not the full loan amount, and you won’t get penalized for repaying early.
4. Plan Your Exit Strategy
The shorter your loan term, the more you benefit from a non-Dutch structure. If you plan to flip or refinance quickly, avoid any loan that front-loads interest costs.
Protecting Your Bottom Line from high interest rates
With LJC Financial, you gain a partner that not only offers competitive hard money loan options but also values transparency and client education. Apply now or reach out to us to discuss your lending needs. Together, we’ll find the optimal loan solution to bring your vision to life.