As I mentioned in my last blog, I will be doing a series detailing how lenders arrive at an interest rate. But before I get into the posts outlining different pieces of the rate puzzle, I do want to point out that there is a big misconception regarding rates.
The misconception is the lowest rate is everything. And it’s not even close to being everything. In fact, I would argue that in the amounts we generally finance (typically between $5,000 and $500,000), the rate is, at best, the fourth or fifth most important thing, behind collateral, several restrictions, and terms.
In fact, I know someone is quite knowledgeable about business when their first question is, “What are the collateral requirements?” or “How flexible is the repayment structure?”. People newer to business typically lead off with “What is the rate?”
Here’s a quick example: John and Mike both borrow $85,000 for a delivery truck. John’s rate is 7%. Mike’s is 8%.
John’s 5-year payment is $1683.10. Mike’s is $1723.49.
So on the surface, John’s payment is roughly $40 less per month, or $480 a year. Multiply that by five years, and that comes to $2400.
Ok, it’s not chump change, but it’s not that big of a factor over five years, either.
But, in John’s loan, he had to put up his house as collateral, as well as having a lien on the truck. That’s why the rate was lower – lessened risk to the lender.
In Mike’s delivery truck loan (written by Crest Capital of course), the truck lien itself was the only collateral.
John risked his home for $2400 over five years. Did he really get a better deal?
I don’t think he did. Most people (and any spouses/family members also living in that house) would agree.
As I go through this entire series, we’ll run into a number of these “tradeoffs”. I’ll highlight them with a Tradeoff Alert.
As this upcoming series will show, there’s a lot that goes into a rate, and there are tradeoffs. And when it comes to small business borrowing, the lowest rate is usually not the best deal.