Other people's money Featured

10:04am EDT July 22, 2002
Lower interest rates have led to a flurry of loan refinancing in both the personal and business markets. Banks are offering highly competitive deals, and now might be the time to re-examine loan terms.

"It's not just the level interest rates, it's the aggressiveness of the banks that makes now a good time to do any sort of financing," says W. David Tull, chair man of Troy, Mich.-based Crestmark Bank. "Banks are very competitive not just in rates, but in terms. You can get a longer amortization schedule and you can borrow more against the same amount of assets than before."

Established businesses with a consistent earning pattern may be able to negotiate a deal a half percentage point under the prime lending rate. The heavy competition has brought rates to around 8 3/4 per cent for five- to seven-year loans.

"This is a good time if you want to re-leverage equipment," says Tull. "You can do it at a low rate, get the cash and amortize it over five to seven years. You could also pay down your working capital line with it and set yourself up for the next go around of expanding the business."

Even a non-established business can usually get a better deal.

"A newer business may not be able to get a fixed rate, but it may be able to drop to prime from prime plus 1 or 2 percent," says John Foster, a managing director for American Express Tax and Business Services. "Many businesses have a line of credit at a higher rate than prime. These are much like credit- card loans. When the rates drop, see if you can roll the credit line into a term line and amortize it over a 60- to 120-month period to help your cash flow management."

There are three points to consider when considering refinancing:

  • Rate. Generally, if you see a percentage point drop in rates, it's time to start looking at refinancing.

  • Costs. Always be aware of how much the loan is going to cost in processing fees or points. For example, if you refinance a $10,000 loan and save $500 in interest costs over the life of the loan, any closing costs must be less than $500 to make the transaction worthwhile. "A lot of banks are advertising no-cost loans," says Foster. "There might not be a loan-origination fee or points, there can be title costs or escrow fees if property is involved."

  • Term. This is how long the loan is financed. Typically, the longer the loan term, the easier it is to make up any fees or closing costs to justify refinancing. Term also affects monthly cash flow. The longer the term, the lower the monthly payment will be, thus the more cash you will have on hand. Sometimes a credit line is better than a term loan.

"If you're financing major equipment, then more than likely you should get a term loan, with a fixed five- or six- year payment period," says Foster. "If the business is seasonal, and you need the money to supplement your cash flow, then go with a line of credit. You can draw it down as necessary, and when the cash comes in, you can pay it partially or completely."

Too much debt?

The aggressive nature of banks means loans that previously would have been denied are being made. Don't assume that because your bank is willing to give you the money that it's the best move for the business.

If you're borrowing to pay for the day-to-day operations, it's a sure sign of trouble. Many owners wait too long before asking for help from a banker or accountant, leaving the experts little time to do anything about the problem.

"Sometime a bank is not doing you a favor if they give you too much money," says Tull. "You need to watch your cash flows carefully. A pattern of fast growth financed with debt is a dangerous way to finance your business. Reassess your financing. What happens if there is a 10 percent decline in your business? Make sure you can survive in a different economy. There are a whole series of companies out there that were born in this boom economy and have never seen bad times."