4 Tips to Managing Your business Loan’s Interest rate

How can you or your business better manage its current interest rates?

Four tips:

1) Should you have A Loan In the first place?

Interest rates are essentially a cost of doing business. Thus, just like any other cost to your company, if your interest rate is too high compared to the returns that those funds will bring in via increased revenue or through cost savings – then you are better off not taking the loan in the first place.

What better way to manage high interest rates then not to have to pay them.

And, if you already have the loan in place (say to buy some new equipment or inventory), if the loan is costing more than it is worth to the business sell off those assets and pay back the loan. It will be better for your business in the long run.

2) Understanding Your Interest rate:

Most rates are based on some risk profile of the borrower. Either credit history, cash flow realization or use of funds.

Think about it. A borrower realizes that running a business is not all that easy and simply walks away from their business loan. That is a big risk especially in this economy.

Or, a business’s cash flow is barely enough to cover the loan payment to begin with then has a slow revenue period. Will that business be able to make the next loan payment?

Or, a borrower wants funding to open a new online business. But, that business is an online gambling site that could be shut down by the government at any time.

If you understand how and why lenders price loans, then you can work to mitigate those risk factors (like improving your credit and cash flow or running a legitimate business).

Thus, you take away their reasons to charge a high rate or increase your interest rate. Even if you have already taken the loan, when your situation improves, go back to the negotiation table and threaten to take your business elsewhere.

You can only help yourself through knowledge.

3) Protect Yourself Before you Take The Loan:

Small increases in interest rates really should not effect your payment all that much (unless it is for very short-term loans like under 12 months).

Example: Let’s say you have a $100, 000 business loan at 8% for 3 years. Then, your rate increases to 10%. Your monthly payment will rise less than $100 per payment. Not great but not really all that bad either. Here is why:

When making your decision to take a loan, you should always understand what you are getting in return for that new cost. If a $100, 000 loan costs you $12, 000 over three years in interest, then those funds should return much more to your company over that same period. If it does not, you should not take the loan.

But, you should also create a buffer in your revenue estimates especially if you know the economy is in a rising interest rate environment.

It your rate does not rise, then that is pure benefit to your company. But, if it does, you are protected or have managed for it.

Let’s say your business requires a 30% return on investment and a $100, 000 loan will cost you $12, 000 over its life. Thus, your company needs to realize some $145, 000 to achieve that 30% ($100, 000 in principle with the remaining to cover your interest costs and return requirement). Thus, you make sure or look for projects that will return at least that amount.

Or, if you think your rate will rise or we are in a poor economy like we are now, then add a cushions. Only accept or look for projects that will return $150, 000 or more. Thus, your interest rate can rise a few percentage points and your business will still realize that 30% return.

The goal here is to manage your interest with your decision before you request any outside debt or funding by picking the right projects or getting a business loan for the right situation only.

4) Paying More:

You can always manage your overall interest rate by paying more in principal. Thus, instead of paying more in interest over the life of the loan to your lender; work to reduce the principal that they can charge interest against.

A $100, 000 business loan at 10% for three years has a payment of $3, 227. And, if you pay the loan out, your total interest would be $16, 162.

But, if you add a little extra to your payment each month (say $580 or 18% increase in your payment) then your overall interest for the life of the loan would drop to $12, 811 – essentially making your interest rate 8% (not 10%).

Here, you are paying more to reduce principal (to your benefit) then to your interest (their benefit).

Further, you end up paying off the loan 7 months earlier.

The higher your interest rate gets (say with a variable rate that keeps rising), the more benefit paying additional principal will help.

The bottom line is that in a rising interest rate environment, your will pay more. But, you can also manage your business loans to ensure that what you do have to pay is being paid to your benefit and not just going to your financial company.

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