At a recent equipment financing and equipment leasing trade show we polled over 125 business owners with a short survey and had various discussions with numerous willing participants. Our main question was simple; if you borrowed $100,000 for your business, what is the dollar amount of interest you would be willing to pay back assuming you have good credit. The majority responded that $10,000 of interest is the most they would want to pay for borrowing that amount. Of course, this was all hypothetical since there wasn’t a specific project in mind but $10,000 was where most owners’ comfort level landed.
We feel many people picked $10,000 because it was 10% of $100,000 which sounded like a reasonable upper limit for them. Then we asked how long a term would they want the loan for and this is where things got interesting; of course some owners said “as long as possible” but for practical purposes a majority of owners responded that 1 to 5 years or something in between would make sense but there was no real emphasis on the term; they simply felt they didn’t want to pay over $10,000 in interest.
Then we asked about interest rate; almost everyone checked the 5-9% rate box as their target rate. Discussing rate was definitely the most emotional question on our survey; chatting about maximum dollar amount of interest or length of term was bland compared to rate talk where emotions ran high. Later in the event we shared the following chart with the participants and some eyes opened wide.
Amount borrowed: $100,000
Interest paid back: $10,000
Term / Interest rate
1 year = 17.9%
2 years = 9.3%
3 years = 6.3%
4 years = 4.7%
5 years = 3.8%
The same amount of $10,000 interest was paid back in each case but as you can see, adding an additional year to the term made a huge difference to the rate. The owners which expressed that a 1 or 2 year loan didn’t make that big a difference to them as far as strategy yet said they would never pay over 10% rate were very surprised to see how big the difference was; almost double.
The key is when you are borrowing money you should first focus on your business cash flow and do an analysis; what dollar benefit does the finance provide back to the company. The second goal is to take out the loan or equipment lease for the shortest term possible which works with the business cash flow while still providing a benefit; the longer you borrow the more dollars it will cost you. Finally, look at the rate; if you’re extending the term another year just to feel better about the interest then you’re not gaining anything except time which may be of value but based on our survey, didn’t really make a huge difference. Focusing on only one aspect will not help you make the best decision for your business.