Transcript – Provided and/or Formatted by BorrowStar
Regardless of the state of the economy, all entrepreneurs, either new at their trade or old hats in business, when seeking financing, tend to get caught up in haggling over the lowest possible interest rate that they can achieve. Who can blame them? Cost savings – especially while we are still experiencing recession like economic symptoms – may be the key to their business’s survival and their personal financial future. But, sometimes, merely basing a financing decision on just its cost (its interest rate in this case) alone can be even more detrimental. All business decisions should be taken in the whole – with both benefits and costs consider simultaneously – especially with business loans. Let me explain: In today’s market, any offer of a business loan – regardless of its costs – should not be taken lightly given the fact that these business transactions are hard to come by.
Thinking that this interest rate is too high and that a better one will come along tomorrow may just be destructive thinking as nothing may come along tomorrow – especially in this continued sluggish economy and all lenders being overly cautious. Further, if the business owner’s decision hinges so much on the rate of the loan, then maybe a business loan is not something the business truly needs at this time or may be a decision that just spirals the business further along an unhealthy path. Example: Let’s take a simple but common business loan situation. A $100,000 loan for 5 years with monthly payments at 8% interest. This loan would require monthly payments of $2,028 for the next 60 months. Now, let’s say the interest rate was 12% instead of 8%.
This would result in a monthly payment of $2,225 – nearly $200 per month higher. A significant increase – nearly 10% higher with the larger interest rate. This is what most business owners, when seeking outside capital tend to get caught up in – the lower rate means more savings for the business and thus a better decision. But, what happens if the current lender will not lower the rate from 12% to 8%? Or, if another, lower rate loan / lender does not come along? Is it still a good business decision?
Looking at the cost of the loan or the interest rate is purely one sided and could potential affect the long-term viability of your business – the benefits of the loan also have to be weighed in. Let’s say that the business can take that $100,000 loan and use it to generate an additional $5,000 in new, monthly business income. Does it really matter the interest rate at this point as the nearly $200 difference in the rate is really trivial (especially over the months period) compared to possibly declining the higher rate loan and getting nothing in return (losing out on the $5,000 in new revenue per month). Or, what if the business would only be able to generate $1,000 in new, extra income from the $100,000 loans? Then no matter what the interest rate (8%, 12% 50% or higher), the business should not even be considering a loan in this situation. Why do I bring this up?
Simply because I have seen business after business either lose out on their future potential or fatally harm their organization over a mere one or two percent increase in a business loan rate. We are just conditioned to think that if we do not get the rate we feel we deserve – then the deal is bad for us. That can not be further from the truth. Know that these conditioning instincts we tend to have are more from the fact that competitors (those other lenders seeking our business) tell us we can do better or that we deserve better – but in end only finding out that those ploys never really work to our benefit. The lesson here is that all business decisions are more complex then we may initially think or been lead to believe. We are taught from very early in life to negotiate for the lowest costs – like zero interest car loans or buy now with “the lowest mortgage rates in decades” – either case, one would not buy a car or a house (regardless of the interest rate) if there was not a great need – a need that provides more in benefits then its costs.
The same should be done with business loans. Loans are merely an asset to a business and should be treated as such. Business loan assets should be used to generate more in revenue than they cost – the more the better. If they are not being used (like any other business asset) to generate the greatest benefit that they can generate, then they should be pulled from whatever use they are currently being employed in and put into use that will generate the greater benefit. It is simply a law of business. Thus, merely focusing on only one side of a business decision – the interest rate for a business loan decision – can have an unforeseen, adverse affect on the business – creating more harm then good.
The entire situation should be taken into advice before a decision is made. In fact, in the case outlined above, the interest rate can increase as high as 56% for the 60 months before the cost would outweigh the benefits – provided there were no additional costs associated with the loan. In my experience, I have always found it much easier to look at the benefits first (like the increased monthly revenue that can be generated) then search out the lowest costs options to receive those benefits. But, as stated, this is essentially opposite of what we tend to be taught in our society or in our markets (remember the zero percentage auto loans – which have the lost interest revenue built into the price). But, sometimes the best entrepreneurs think outside the box and tend to go against any conventional wisdom we may have been subject to – mostly for the benefit of others and not ourselves. Therefore, when seeking a business loan and finding yourself fighting hard for a small decrease in your interest rate – be sure to step back for a moment and look at the entire picture – as a low interest business loan may not be in the best interest of the business in all circumstances.