Certainly every borrower wants the lowest rate of interest they can obtain. However, when it comes to securing business financing it is important not to focus just on the lowest rate, writes Investment Manager Bill Girard. Ignoring other factors could be detrimental to your business health.
The interest rate is only one element of a loan. Others include the amount you are able to borrow, the size of your monthly payment, the length of the payback period and type of collateral. Is putting your house up as collateral part of the picture? These and other terms and conditions of any business loan should be considered along with the interest rate charged. In fact, it's very possible that taking the loan with the lowest rate of interest may not be your best option. What do I mean by this?
First, let's look at some numbers regarding rates and monthly payments. If you are borrowing $50,000 and one lender's rate is 1.5 percentage points above that offered by another lender what does this mean for your business? If both loans are structured to be paid off just as quickly—let's say over 36 months—you will pay approximately $35 per month more for the higher rate loan or $420 more each year. If however, the higher rate lender is prepared to let you pay the loan off more slowly—over 48 months instead of 36—you will actually pay $310 less per month or about $3,720 less each year with the higher rate. Understand that you will pay more in total interest over the term of the loan with slower repayment (longer amortization). This is simply because the loan balance on which the interest is charged is outstanding longer. However, if keeping your monthly payments lower is important then going with the lender that is charging the higher rate, but with the longer amortization, may be the better option.
One benefit of the lower payment is that you have more discretionary cash to work with and invest in your business. If you are at a stage of business growth where this is important then the higher rate and lower monthly payment loan may be preferred.
Another consideration is the amount you are able to borrower from different lenders. Let's assume you conclude that having more capital at your disposal is desirable. Then being able to borrow more from a lender that is prepared to provide you more cash is clearly worth serious consideration. The increased profits you could generate from having more money to invest in your business could offset the marginal cost of a higher rate loan.
Many small business owners don't examine their lending strategies at this level. They typically go to their familiar financial institution, take that lender's stated terms, and conclude “that's all that's available”. Prudent financial management for your business should compel you to “get a second opinion” and weigh the advantages and disadvantages of alternative lenders. Simply getting the lower interest rate may not be in your best interest.