How do legal fee loans work?
A legal loan is a type of personal loan. While the pieces are the same, a legal loan works a little differently from what you might expect from a standard personal loan. Let’s look at the elements that make up a legal loan:
Interest rate
Borrowing money helps people access the financial support they need, but it does come at a cost. Like most loans, legal loans need to be paid back with interest. The amount of interest paid on top of the amount borrowed is a percentage of the amount owed. It’s usually measured as an annual rate and is called the Annual Percentage Rate (APR) or Advertised Rate.
And remember, the lowest interest rate doesn’t always mean the best loan for your clients. Be sure to consider the total cost of the loan including interest, fees and other costs to get a complete picture.
Repayments
This is where most personal loans and legal loans differ. With a standard personal loan, once your clients receive their loan, they need to start paying it back through regularly scheduled repayments, either weekly, fortnightly or monthly.
A legal loan is different. It’s secured against your client's forthcoming property settlement and it’s not expected that they will have the cash to start repaying the loan until they receive this settlement. So, rather than repay the loan in instalments, they'll repay it as a lump sum out of their share of the property settlement once it’s finalised.
Your clients also only access the money when they need it. So if they don’t draw down their entire loan amount, they'll only pay interest on the amount they actually accessed.
Loan amount
The loan amount is the amount of money your clients borrow, plus any fees and charges capitalised into the loan amount. It’s this amount that they'll pay interest on. However, with a legal loan, they only draw down the money as they need it. So they only pay interest on the amount they access.
In Australia, legal loans usually range from $25,000-$400,000.
Loan term
When your clients take out a standard personal loan, they agree to the length of time it will take them to repay the loan. For personal loans, where they also commit to making regular repayments, lenders usually offer loan terms between 1 and 7 years.
With a legal loan, however, your clients are only expected to repay the loan once their property settles. So the loan term for legal loans allows for this process to happen – typically up to 2 years. If their property doesn’t settle within the 2-year loan term, an extension may be available.
Upfront fees
Most loans also come with an upfront cost to set up the loan. Known as upfront, establishment or application fees, they can include:
- A flat fee (e.g. $499) that applies regardless of the value of the loan
- A tiered fee (e.g. $250, $500, $750) based on the value of the loan
- A percentage fee (e.g. 3%) based on the total amount borrowed and the credit or risk profile of the customer
- A hybrid fee (e.g. $200 + 2% of the loan amount)
It’s up to the lender what fees they choose to charge. But keep in mind, these upfront fees aren’t actually paid upfront – they’re usually capitalised to the loan balance, meaning they are paid back with the remainder of the loan. This increases the total loan amount, meaning your clients will be paying interest on those fees as well for the life of their loan. If it’s a small upfront fee, it might not make much of a difference. But if the fees are significant, they can add thousands to the total cost of the loan.
Monthly or ongoing fees
Most loans also come with a monthly cost. Also called ongoing, account-keeping or loan management fees. These fees don’t go towards paying back the loan. In general, the lower the fees, the better. But as always, the total cost of the loan should be considered including all interest payable and other charges.
With a legal loan, your clients will still be charged a monthly fee, but it will also be capitalised into the loan, so they pay it at settlement.
Penalty fees
Missed payment or ‘default’ fees are the most common penalty fee for personal loans. They’re a more relevant risk when your clients are repaying their loan monthly because one late payment can result in a fee. Late fees can vary from $10 to as much as $35 per default.
With a legal loan, your clients are not required to make monthly repayments, so they're at less risk of defaulting. If their settlement hasn’t come through by the end of your loan term, an extension might be possible.
How much does it cost?
To work out the overall cost of legal fee loans, your clients need to factor in:
1. Loan Interest Rates: The biggest factor in how much a legal loan will cost is the rate of interest your clients will pay on the amount borrowed. Legal loans can come with variable or fixed interest rates. If your clients are opting for a variable-rate loan, it is best to also calculate a worst-case scenario, one where a loan’s interest rates rise significantly in the future to be sure your clients have a comfortable buffer in the event things change. At Plenti, our legal loan interest rates are always variable. Interest is only paid on the amount outstanding, once a settlement is reached.
2. Upfront Fees: ‘Establishment’ or application fees for all loans can vary greatly, so it’s an area where shopping around can make a difference.
At Plenti, we have one upfront fee on our family law loans. The credit assistance fee is 3% on the amount of credit sought. This is a one-off fee capitalised to the loan at the time of the initial drawdown. This means your clients won’t actually pay the fee upfront, rather, it will be added to their repayments at the time of settlement.
3. Ongoing Fees: These fees are charged throughout the life of the loan. Common ongoing fees include:
- Monthly or annual fees (also called account keeping fees)
- Default, dishonour or missed payment fees
- Hidden fees in the terms and conditions of a loan
At Plenti we never add hidden fees. We charge two types of ongoing fees for legal loans:
- A drawdown charge, which is 5% on every dollar drawn down on the loan
- Some loans also require a security fee, if caveats are required for the security of the loan, these fees are $980 for caveats and $1300 for mortgages
Each of these fees is capitalised to the loan, so your clients only pay them once they begin making repayments.
To find the true cost of a loan, you can combine the costs of these fees with the interest rate of the loan. As long as you are comparing the same loan terms and amount, a comparison rate helps you to compare the cost of different loans.
At Plenti, typical borrowers incur effective costs of about 8.55% p.a. over a 2 year loan
Now that you understand the building blocks of a legal loan, you’ll be better able to decide which loan is suitable for your clients. Planning and considering their situation upfront will help when comparing what loan products are available that might really fit your clients needs, and offer the best value.