Legal Definitions - below-market loan

A below-market loan is a loan provided at an interest rate that is lower than the prevailing rate a commercial lender would typically charge for a similar loan under comparable circumstances. The "market rate" refers to the interest rate that would be charged by an unrelated, arm's-length lender to a borrower with similar creditworthiness and for a loan with similar terms, collateral, and repayment schedule.

These types of loans often arise in situations where there is a pre-existing relationship between the lender and borrower, such as family members, an employer and employee, or a charitable organization and its beneficiaries, where the primary motivation is not purely commercial profit.

• Example 1: Family Assistance

  A grandparent lends $200,000 to their grandchild to help them purchase their first home. The grandparent charges an interest rate of 1.5%, while commercial banks are currently offering mortgages at 6.0% for borrowers with similar credit profiles. This arrangement allows the grandchild to afford the home with lower monthly payments.

  Explanation: The 1.5% interest rate charged by the grandparent is significantly lower than the 6.0% market rate offered by commercial banks for a similar home loan. The grandparent's motivation is to assist their grandchild, not to earn a commercial return, making this a below-market loan.

• Example 2: Employee Benefit

  A large corporation offers a relocation loan of $50,000 to a newly hired executive to cover moving expenses and initial housing costs. The company charges 2.0% interest on this loan, which is repayable over five years. For a personal loan of a similar amount and duration, a bank would typically charge 7.5% to an individual with comparable credit.

  Explanation: The 2.0% interest rate provided by the corporation is substantially less than the 7.5% a commercial bank would charge for a similar personal loan. The company offers this as an incentive and benefit to attract and retain talent, not as a profit-generating lending activity, thus qualifying it as a below-market loan.

• Example 3: Community Development

  A non-profit community development financial institution provides a $75,000 loan to a small business owner in an economically disadvantaged neighborhood to expand their operations. The institution charges 3.0% interest, aiming to foster local economic growth. Commercial banks, due to perceived higher risk in the area, would typically charge 8.0-9.0% for a similar business loan.

  Explanation: The 3.0% interest rate offered by the non-profit is considerably lower than the 8.0-9.0% that commercial banks would charge for a comparable business loan. The institution's mission is community development and support, not maximizing profit, which enables them to offer loans below the standard market rate.