The journey toward aircraft ownership can be an exhilarating prospect. Whether you’re a seasoned pilot or an aviation enthusiast with dreams of taking to the skies, owning an aircraft is enticing. However, before you can spread your wings and soar through the clouds, there’s an important part to consider— financing your aircraft.
Navigating the intricacies of aircraft financing can be challenging for beginners. The process involves a unique set of considerations, from understanding the financing options available to evaluating your financial capacity. This blog post breaks down the basics of aircraft financing, giving you the knowledge and confidence to make informed decisions on your journey toward aircraft ownership.
Prepare your financial picture
The first step in the aircraft buying process is having a clear picture of your financial situation and how this looks to a lender loaning money for an aircraft. Some things to consider at this point include:
1. Interpreting your tax returns
One part of understanding what your financial picture looks like is what your tax returns convey to a lender. It’s fairly common to encounter individuals with large earnings who, due to their CPA and tax advisor’s expertise, show minimal income on their tax returns. While this is a testament to the financial team’s skill, it can present a challenge for aircraft lenders.
To navigate this, it’s imperative to view your tax returns from a lender’s perspective. This insight will dictate how much of an aircraft you can realistically afford, letting you set a budget for your purchase. Sometimes, it may even require a few years of financial planning to optimize your financial statements, particularly if you’re a business owner or plan to register the aircraft under a business entity.
2. Planning and preparation
Preparation is key. Consult with business aviation and tax consultants, CPAs or financial advisors, who can shed light on your current financial state and what changes might be needed to enhance your financial standing for the eventual purchase. This knowledge can make a substantial difference in your ability to secure the financing you need.
3. Consider your timeline
Understanding when you plan to buy an aircraft is equally important. For example, waiting until the last minute, as tax deadlines loom, to realize the need for an aircraft can lead to unnecessary financial stress. It’s beneficial to have these conversations well in advance to align your financial situation with your aircraft goals.
4. Evaluating liquidity
Liquidity, as perceived by lenders, primarily revolves around cash on hand or in non-retirement investment accounts readily available in your bank. Lenders want assurance you have the liquidity to cover the required down payment, typically 15 to 20 percent. Moreover, they expect your down payment won’t deplete your liquid assets, and you will have additional funds set aside for related expenses, such as taxes, maintenance and hangar fees.
5. Understanding taxable income
Lenders will also look at taxable income. This usually comes into play with business owners, where the difference between reported income on tax returns and the actual financial state of the business can be significant. Aircraft lenders focus on underwriting the individual rather than the business, which may require seeking lenders with expertise in underwriting businesses specifically.
Apply for a loan and get an approval
Your financial picture and standing also carry significant weight in the loan application process, which is the next step in financing an aircraft. Unlike more conventional loans for items like cars or houses, aircraft financing is in a league of its own.
This distinction comes primarily from the size of the aircraft market relative to other loaned assets. The aviation market is relatively small, and this has a profound impact on how lenders perceive risk. In aircraft financing, lenders do not have the luxury of spreading their risks across vast portfolios.
Due to the limited market size, aircraft lenders take a hands-on approach to portfolio management. The consequences of a loss on an aircraft are felt much more intensely compared to other asset classes. This reality is why the process for applying for an aircraft loan is markedly different and more comprehensive than for other, more commonplace loans.
Given the intricacies of the aircraft loan application process, it’s important to factor in the potential extra time it will take for approval. This means including ample time to complete the application and collect your supporting financial documents.
Documentation requirements for aircraft loans are usually demanding, especially if you have multiple businesses. Lenders typically ask for two to three years’ worth of comprehensive financial records, including tax returns and business financials. While long-term liquidity is rarely a major focus, recent bank statements may be needed to confirm the liquidity figures in the financial documents.
The next part of applying for an aircraft loan is the approval time frame. Lenders will provide an approval valid for up to 90 days, giving you time to identify an aircraft if you haven’t done so already. Some lenders, depending on the aircraft, may provide approval without a firm date but lock rates in before closing. Both of these pre-approvals will play into your overall purchasing timelines and goals.
Negotiate the purchase and creating a purchase and sales agreement
The next step in the aircraft financing process is to negotiate the purchase. This phase involves considering what should be included in the purchase and sales agreement.
Consider a few key elements in this phase, such as if a deposit or earnest money will be required to hold the aircraft; if so, is this refundable or non-refundable, and who will hold the deposit?
The purchase and sales agreement should include the four fundamental elements:
- Identifying the buyer
- Specifying the seller
- Describing the aircraft
- Stating the purchase price
Purchase agreements come in various lengths. The level of detail is less important than including these four essentials. Beyond these four elements, the agreement’s specifics are largely negotiable between the buyer and seller. Some buyers prefer comprehensive outlines, while others are more flexible.
Lenders will want to review a copy of the purchase agreement to ensure it is an arms-length transaction but also to provide critical information to determine the financing amount they should extend, gauge the down payment you can afford and outline the terms of the agreement.
One significant part that needs to be discussed in the purchase agreement is the pre-purchase inspection, especially on larger acquisitions. Lenders typically require this inspection to be conducted by a fair third party. Even if you have an A&P on staff, it’s advisable to use an independent party to reduce potential biases.
An important part of the negotiating process and the financing you receive from a lender revolves around the aircraft’s valuation. While the true value of an aircraft ultimately hinges on an agreement among the buyer, seller and lender, having a valuation serves as a useful first benchmark for estimating the general retail worth of an aircraft. A valuation considers a range of intangible factors, such as the model’s availability, its damage history, maintenance record and refurbishments and upgrades. Hiring a professional aircraft valuation service can help determine a good valuation for the aircraft you are considering.
Obtain insurance
A critical step in the aircraft financing process is insurance. Lenders will invariably insist on insurance as part of the financing arrangement. They will require both motion and not-in-motion coverage, which encompasses on-ground and in-flight scenarios.
Even if you plan to park the aircraft for an extended period, for example, an overhaul of the interior or new paint, the lender will still require comprehensive coverage. This includes liability coverage along with hull coverage. The specific limits for hull coverage will typically be set at either an amount equal to the loan or the purchase price. Note that these limits may vary from one lender to another. Some lenders are content if the loan amount is covered, while others may mandate coverage up to the full purchase price.
In addition to the breadth of coverage, lenders pay close attention to certain parts of the insurance policy. They look for breach of warranty coverage, meaning that even if the aircraft owner engages in activities not covered by the policy, the lender is still protected. Lenders insist on being listed as the loss payee on the insurance policy.
Additionally, some lenders may restrict the maximum allowable deductible, usually based on a percentage of the purchase price. As long as the deductible falls within a specified dollar limit or a percentage threshold, the lender will generally be comfortable. However, if the deductible exceeds these parameters, it may require further discussion with the lender.
If the insurance provider cannot offer a deductible within reasonable bounds, it’s worth considering and discussing with the lender. This open communication ensures all parties are on the same page and that the insurance coverage aligns with the lender’s expectations.
The closing
With the approval secured and the negotiations finalized, you’re on the cusp of finalizing the acquisition of your aircraft. At this point, lenders will require the use of a title and escrow service for closing the transaction.
The title company plays a pivotal role by conducting a comprehensive title search on the aircraft, verifying there are no encumbrances or title discrepancies. This title search ensures the lender maintains a first lien hold on the aircraft.
Additionally, they can navigate the complex and often challenging FAA paperwork process. Their familiarity with FAA requirements guarantees the documentation submitted meets the agency’s standards. Many title companies have offices near the FAA records building in Oklahoma City, enabling them to file paperwork quickly on closing day. This expedites the confirmation of ownership, leaving no room for ambiguity in filed documents or the seller’s residual interest in the aircraft.
Ultimately, an escrow service eliminates uncertainties, benefiting the buyer and seller. The escrow service assumes the important role of helping transfer funds for the purchase, acting as an impartial intermediary.
After closing, the escrow service’s involvement ends. Unlike a mortgage scenario, there is no ongoing escrow account for taxes and insurance. These are independently managed outside of the purchase process. The lender remains focused only on receiving payments for the loan.
Prior to the closing process, you’ll want to make sure all aircraft documentation is complete. This includes Log book entries, maintenance records and annual inspections. Lenders typically request copies of the most recent annual inspection and any required phase one, two or three inspections.
Closing costs, including fees for the lender and sometimes brokers, will be factored into the transaction. These costs vary depending on the lender. Some may have a fixed fee despite transaction size, while others base the cost on a percentage of the transaction. This percentage can range from a quarter point to three-quarters of the transaction size.
It is strongly encouraged to involve professionals who specialize in aircraft title and escrow services. Without this expertise, mistakes can occur, potentially causing frustrating complications. For example, one common mistake is trying to include the aircraft under a business insurance umbrella without understanding the necessary coverages. Seeking insurance quotes from multiple aircraft insurance providers can help.
Conclusion
If you are considering purchasing an aircraft, it is important to understand the basics of the aircraft financing process. Aircraft financing stands apart from conventional transactions. Familiarizing yourself with the basics of aircraft financing sets the stage for a smoother and more enjoyable buying experience.
Understanding the five main steps outlined above empowers you to align your expectations. It lets you to determine the aircraft within your financial reach and timeline for making the deal and taking to the skies. From organizing your financial picture for potential lenders to ensuring all required paperwork is in order for the FAA, understanding the process can be rewarding.
Given the unique nature of aircraft financing, entrusting the process to specialized professionals is instrumental. Aircraft financing experts have the knowledge and experience to guide you through every facet of the journey with precision and professionalism. Their expertise adds immense value, ensuring your aircraft acquisition is a seamless and stress-free experience.
Many thanks to Brian Macbean Director of Credit and Sales and Emily Meczkowski, Director of Operations & Marketing at AOPA of AOPA Aviation Finance Company for their contribution to this article.