Using Your Loan Term To Your Advantage

When most small business entrepreneurs seek business loans, they tend to get a bit myopic about two items; the loan's interest rate and the loan's payment.

While these items are of extreme importance because if mismanaged they could be extremely costly to the business. But, these items are usually out of the control of the business owner. Most interest rates today are set based on the lender's costs of funds (not the risk of the borrower) and the payment is what the payment will be when all is said and done.

However, there is one factor that most borrowers overlook - a factor that they can control in part and use to their advantage: the LOAN TERM.

How can a business owner use their loan's term to their advantage? Easily, as the loan term can provide your business flexibility - giving you the opportunity to reduce your overall interest as well as manage your payments during both slow and up periods.

Here's how:

Let's take a simple scenario. Your business borrows $50,000 for 3 years at 10% resulting in a monthly payment of $1,614. You have tried endlessly to get the lender to reduce your interest rate - even just 1 percentage point (you actually want a 3% reduction) to help with your monthly payment. A 1% reduction would lower your monthly payment to $1,590 - a bit more affordable. But, your lender will not budge.

Here is where your loan term can come into play. You then ask your lender to extend the term of the loan to 5 years. At five years, your monthly payment would be $1,063 - some $500 per month lower then it would have been should you convinced the lender to lower your interest rate (what you fought so hard for).

But, would this not mean that you would pay more interest over the life of the loan - two additional years of monthly payments means two additional years of interest payments at 10%?

The answer on the surface is yes - but, not when you bring in the flexibility of the longer loan term.

If your business took the deal at a term of three years, your payment would be $1,614 as stated. Thus, you have to meet that minimum amount each and every month. But, what happens when you have a slow month and struggle to make that payment? You go into default and lose your business. However, with the 5 year loan term, you can still make the larger $1,614 monthly payment. But, if you have a slow month, you can reduce that to the required minimum of $1,063 - still staying within the guidelines of the loan agreement. Then, the next month or during your next better sales period, make up the difference; bringing your past payments back to the higher level.

If you can maintain the higher level - either by making that monthly payment each month or making up for short falls in later payments, you can still pay off that business loan in three years - not costing your business anything extra while having the flexibility (or taking the stress off your shoulders) when your business faces a slow month or period.

The bottom line here is to take the longest term that your lender will allow as this provides you payment flexibility; flexibility to match the ups and downs of your business's revenue and cash flow - as we all know revenue fluctuates - even though your loan payment doesn't.

With the longest term possible, this gives you, the manager of your business, the opportunity to manage your business loan - making higher payments when feasible and meeting the minimum level when necessary.

The only caveat here is that when financing fixed assets, lenders will match the term to the life of the asset. So know the life of the assets being purchased. With working capital or non-asset purchase loans - the loan term should be negotiable within reason.

Know this: Small business loans are essentially a tool to be used by the business - just like any other tool or asset. So, find ways, like longer loan terms, to utilize these tools (business loans) to your advantage.

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