Defaults are when borrowers, at some point in the loan’s life, cease making their payments. For this post, the reasons why are immaterial – at the end of the day, all that matters is the lender is out not only a (sometimes large) portion of the money they lent, but they are also out of the expected revenue from the interest. Since most businesses use some form of projected/expected income to operate, this is doubly bad for a lender. And no, “writing it off” does not make a lender whole by any stretch.

But it isn’t just the money/revenue lost. Most of the time, there was some form of collateral involved with the loan, which now must be repossessed. This costs money, as someone has to be paid to collect it. One other issue here: Since the borrower is generally in some kind of financial straits, this is typically not a pleasant experience. 

In addition, in most cases, the collateral does not make the lender whole. They still need to sell the item, and they almost never recoup even close to what is owed.

There’s another aspect to defaults that often goes unnoticed by those outside the lending industry: how defaults make a lender look to regulators. Too many defaults will often bring increased regulation on the lender, and increase their capital requirements. Nevermind that perhaps the defaults were an anomaly and not really the lender’s fault. That won’t matter to the regulators; to them, the lender is writing too many risky loans and will be treated as such.

Lenders use an immense amount of data to qualify borrowers, and, much like the insurance industry, attempt to predict default rates based on various lending criteria and borrower/loan profiles. Now, of course, lenders can’t predict which specific borrowers may default, but they do have to honor what the data tells them about the aggregate. These predicted default rates are factored into the lender’s overhead and become part of the rate equation.

Despite the lender’s best efforts and the borrower’s best intentions, defaults in the lending industry are inevitable and must be accounted for.

I wish I knew the answer, but I don’t. Nobody does. We’ve seen rates rise all year, most recently at the beginning of November. And to my eyes (as well as to most economic pundits), the end is not in sight.

Rates have been rising to combat inflation. But inflation remains stubbornly high, so the thought is the Federal Reserve is going to keep raising them until inflation is tamed. And unlike a scary movie franchise where everything thinks the villain has been vanquished, only to reappear stronger than ever, the Fed is unlikely to lower rates until they are absolutely sure inflation has been handled. No surprises, and no “Scary Economy Part IV, Inflation in Space!” 

What this means is even if inflation peaks, we should not expect rates to start falling immediately after hearing that news. It’s going to take time, and then the decreases will likely be very gradual. 

Ok, so what does that entail for all of us? It means this is the economy and rate environment we must work with. It also means that “waiting” out rate hikes is likely to be a futile, and possibly harmful, strategy. 

Companies cannot afford to sit idle for months and years. They need to replace equipment, they need to offer new services, and they have to keep pace with their competitors. One of the reasons inflation is high is demand is still exceeding supply. There is ample money being spent and commerce happening – in fact, many companies can’t keep up with demand. So now is not the time to turtle up. 

I promise you this: rates are going to come down – eventually. But again, it will be a while before it starts, and (in my opinion) the fall will be gradual. When will they reach late 2021 numbers? Goodness, that could take years. I mean, I hope it doesn’t, but I’m also pragmatic, and in my mind, everything is pointing to more increases.
I’ve mentioned this before, but getting in now and locking in a fixed rate on equipment financing could be a very savvy move a year from now, because we are nowhere near the peak yet.

It’s been awhile since I posted about Section 179, so let’s discuss this thoroughly awesome tax deduction.

It’s the time of year when you should start thinking hard about Section 179 – especially if you haven’t bought any qualifying equipment yet. That’s because congress raised Section 179’s deduction to a robust $500,000. This means you can buy equipment now, and write off the entire purchase price this year, for up to a cool half mil.

The amount of money this allows you to keep at tax time can be substantial. Figuring a conservative tax rate of 25%, a $100,000 piece of equipment (thus a $100,000 tax deduction) translates to $25,000 in real dollars that stays in your bank account (as opposed to going to Uncle Sam’s).

You can look at that 25k several ways:

1. If you paid cash for the 100k piece of equipment, you could say you got a fat 25% discount.
2. That 25k can be added to your bottom line.
3. If you financed the 100k, well, I need a little more space, because it’s a big deal…

If you financed that 100k right now (late September), you will likely pay 2-3 payments this year, then get a $25k savings on your taxes. Netted out, this means you paid nothing for the equipment this year.

It gets better – until your payments equal the 25k you saved, you still theoretically paid nothing for the equipment.  So perhaps you get to use the equipment for free all of next year too!

But wait, there’s more!!!

Since from Sept of this year until that 25k is met, the equipment costs you $0 in net dollars. But all of that time, the equipment is being used, generating you revenue. This pushes the time the equipment actually “costs” you money out even further. Depending on how much revenue that equipment generates, your payments may never catch up to the money you kept (the net 25k from the deduction), and the additional revenue generated. So in essence, the equipment was free.

Read that again if you have to. Here, I’ll make a quick math equation:

TS + (NR x T) – TMP = P$

Tax savings (TS) plus new revenue (NR) over the term (T) less Total Monthly Payments (TMP) = Profit (P$)

I know, it sounds too good to be true, but it isn’t. That’s why Section 179 rocks!