How to price loans when your cost of capital changes

When your cost of capital changes, rebuild your pricing from the bottom up: work out what each funding source now costs, blend those costs by how you actually fund a typical loan, add servicing, expected losses and your target margin, and then decide whether to pass the change through in the rate, the points or both. Until you do that, every loan you quote at the old price is quietly funded out of your margin.

This guide covers the mechanics of repricing, not rate forecasts. For the components of a price, see how private lenders price a loan; for how rate moves affect exits and values, see how interest rate changes affect private lending. If a line is a large part of your funding, our warehouse line of credit alternative page explains a source whose cost doesn't move with an index.

Key takeaways

• Your cost of capital is a blend of your own capital, investor notes, a line's index plus spread and, for placed loans, the capital partner's target yield.
• Each source reprices on a different clock: a line at the next index reset, investor notes at the next raise.
• Rebuild the rate sheet from the blended cost plus servicing, expected losses and margin.
• Rate or points? A change in funding cost is an annual cost, so it belongs mostly in the rate. Points recover it only over the hold you expect.
• Protect the gap between quote and closing with term sheet expiry dates, pricing validity windows and, on floating-rate loans, floors where your documents and the law allow.

What makes up a private lender's cost of capital?

A private lender's cost of capital is the weighted cost of every dollar in its loans. Most lenders draw on some mix of these:

• Your own capital. It has no invoice, but it has a cost: the return you could earn elsewhere, or the return your owners expect.
• Investor notes or pooled investors. The rate you promise investors, plus the cost of raising and administering the money. Raising from investors may be a securities offering, so consult counsel on structure.
• A credit or warehouse line. Usually a floating rate: an index plus a spread, plus fees and the equity haircut you fund yourself. Many facilities reference SOFR, which the New York Fed describes as "a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities" and publishes each business day. The all-in cost of a line is higher than its headline rate; our guide to warehouse funding costs shows how to model it.
• Direct capital placement. When a capital partner funds the whole loan, you don't carry a funding cost, but the note rate has to meet the partner's target yield. Your economics come from the points, less a placement fee.

How does each funding source pass a change through?

Each source reprices on its own schedule, so the same market move hits your blended cost in stages.

Funding source	What sets its cost	When a change reaches you	What to check
Own capital	Your target return	When your alternatives change	Whether idle cash is earning anything
Investor notes	The rate you pay investors	At new raises and renewals	Existing notes keep their rate until they roll
Credit or warehouse line	Index plus spread, plus fees	At each index reset, and the spread at renewal	Index floors, pricing grids, renewal date
Direct capital placement	The capital partner's target yield	On the next loan you submit	Whether your note rate still meets partner criteria

Lines have a second clock: renewal. The OCC's Asset-Based Lending handbook notes that collateral-based lines are "often priced based on a complex structure of fees and loan spreads that change based on performance," and that short maturities let the lender adjust the commitment, advance rate and interest rate. Federal Reserve research on warehouse lines found most were tied to a floating benchmark and most had maturities of less than one year, so a borrower "can face higher funding costs" at renewal if market conditions have changed (Kim, Laufer, Pence, Stanton and Wallace, FEDS 2018-016).

Capital partners reprice too. They compare your loans with other uses of their money, so it helps to track public benchmarks such as the Federal Reserve's H.15 selected interest rates, which includes Treasury yields and other market rates, published each weekday.

How do you rebuild a rate sheet when your funding cost moves?

Rebuild it from the funding cost up, one product at a time. A simple method:

1. Map how you fund a typical loan in each product: for example, 75% line and 25% your own capital, or 100% placed with a capital partner.
2. Price each source today: the current index plus your spread, the rate on your next investor raise, your target return on equity, or the capital partner's target yield.
3. Blend them by the funding mix to get a cost of funds.
4. Add the costs of holding the loan: servicing and overhead, and an allowance for expected credit losses that fits the product's risk.
5. Add your margin if it isn't already in your equity return, and round up to your sheet's increment.
6. Check it against the market. If the new rate prices you out, change the product (leverage, size, term) rather than cutting margin to zero.
7. Date the sheet and set how long quotes from it are valid.

A hypothetical worked example

Every number below is hypothetical, chosen only to show the method. None is a quote, a market rate, a capital partner's target or a Lender Capital term.

A lender funds its bridge loans 75% from a line priced at an index plus 3.50% and 25% from its own capital, on which it targets 12%. The index rises from a hypothetical 4.00% to 4.75%.

Pricing component	Before	After
Line rate (index + 3.50% spread)	7.50%	8.25%
Line share of the loan × line rate	75% × 7.50% = 5.63%	75% × 8.25% = 6.19%
Equity share × target return	25% × 12% = 3.00%	25% × 12% = 3.00%
Blended cost of funds	8.63%	9.19%
Servicing and overhead	0.50%	0.50%
Expected credit loss allowance	0.75%	0.75%
Required note rate	9.88%	10.44%
Rate sheet, rounded up	10.00%	10.50%

A 0.75% move in the index raised the required rate by about 0.56%, because only 75% of the loan is funded from the line. If the line had a spread step-up at renewal as well, the change would be larger.

Rate or points? If the lender held the rate at 10.00%, the shortfall is about 0.44% a year. On a $400,000 loan held for the full 12 months, that's about $1,750, or roughly 0.44 points. If the loan pays off after six months, the shortfall is only about $875, so an extra half point ($2,000) would recover more than twice the cost; if it's extended, points recover nothing for the extra months. Because a funding cost accrues for as long as the loan is outstanding, it belongs mainly in the rate, and points are a rough substitute that depends on the expected hold.

If the loan is placed instead. Suppose a capital partner's target yield for the same loan rises by a hypothetical 0.50%. The note rate has to rise by that amount for the loan to place with the same yield spread for the lender. If the market won't bear the full increase, the lender's spread above the partner's rate narrows instead. Its points less the placement fee don't change, and no capital is tied up.

How do you protect margin between quote and closing?

Limit how long any price stays open: the gap between quote and closing is where repricing risk lives.

• Term sheet expiry dates. State how long the quoted terms stand, and what happens if the loan doesn't close in time.
• Pricing validity windows. Date every rate sheet and say how long it applies to new applications.
• Rate locks, used sparingly. A lock is a promise. The OCC's Mortgage Banking handbook explains that when a borrower receives a rate lock, the lender "has in effect provided a put option to the borrower" without being paid for it: if rates rise the borrower closes, and if they fall the borrower may walk away. If you lock, limit the term and consider a fee.
• Floors on floating-rate loans. If you make floating-rate loans, an index floor stops the rate falling below a set level. Check your line, too: if your line has an index floor and your loans don't, a falling index can cut your loan income faster than your funding cost.
• Extension pricing. Set extension fees and terms in the loan documents up front, so an extension is priced at today's cost, not the cost when the loan closed. See bridge loan extension requests.

Usury limits and fee rules vary by state and loan type, and business-purpose loans can be treated differently from consumer loans. Consult counsel before changing how you charge rates, floors or fees.

When should you pass a cost change on to borrowers?

Pass it on for new quotes as soon as your sheet is rebuilt, and honor anything you've already committed to. In practice:

• New applications: price from the new sheet from the day it's dated.
• Issued term sheets: honor them within their validity window. Re-quote after expiry.
• Closed fixed-rate loans: the rate doesn't change. The cost lands on you until payoff, which is one reason short terms and clear extension terms matter.
• Extensions and modifications: price at current cost where the documents allow.
• Falling costs: decide on purpose: pass savings through to compete, or keep some to rebuild margin.

If your volume depends on one floating-rate line, every move in its index forces this exercise. Diversifying funding, including sources priced per loan rather than per index, can make your pricing steadier. See credit facility vs. warehouse line vs. forward flow and how private lenders fund more loans.

Frequently asked questions

How does cost of capital affect loan pricing?

A lender's rate has to cover what its money costs, plus servicing, expected losses and margin. When the blended cost of its own capital, investor money and credit lines rises, the rate needed to keep the same margin rises with it.

Should a private lender raise the rate or the points when funding costs go up?

Mostly the rate, because a funding cost accrues for as long as the loan is outstanding. Points recover it only if the loan stays out as long as you assumed, so they overcharge on early payoffs and undercharge on extensions.

How long should a private lender's term sheet or rate quote be valid?

Long enough to close a typical loan, and no longer. It depends on your process and how fast your funding costs move, so set a stated window, date every sheet and shorten the window when costs are changing.

How Lender Capital fits

With direct capital placement, the loan's funding cost isn't yours to carry. Lender Capital places first-lien, business-purpose real estate loans (bridge, fix and flip, ground-up construction, DSCR rental) from reviewed lenders with capital partners who see the full file before committing. One capital partner funds the whole loan at closing, the loan is assigned to it at closing, and you keep servicing and the borrower relationship. You pay a placement fee from your origination points, only when the loan funds. You keep your points and earn a yield spread: you set the borrower's note rate, the capital partner receives its agreed rate, and the difference is yours.

Compare it with a line on our warehouse line of credit alternative page, see how it works for lenders, or apply as a lender.

Sources

• Federal Reserve Bank of New York, Secured Overnight Financing Rate (SOFR)
• Board of Governors of the Federal Reserve System, H.15 Selected Interest Rates
• Office of the Comptroller of the Currency, Comptroller's Handbook, Asset-Based Lending
• Office of the Comptroller of the Currency, Comptroller's Handbook, Mortgage Banking
• Kim, Laufer, Pence, Stanton and Wallace, Liquidity Crises in the Mortgage Market, Finance and Economics Discussion Series 2018-016, Board of Governors of the Federal Reserve System