The interest rate topic drives some business owners into making rash decisions. All owners want to pay the lowest rate possible but we’ve seen some work hard to qualify for a good rate, providing all the requested documentation and then lengthen the term of the finance just because they are used to paying everything on the longest time table possible. Even though they can make higher monthly payments they choose the lowest monthly payment possible which is not the best way to conserve capital. A common scenario would be as follows.
Term and payment: 36 months = $3,088 per month
Total interest expense: $11,168
Term and payment: 60 months = $1,980 per month
Total interest expense: $18,800
The client, by taking option #2 which has the longer term and considering the other parameters are the same, is paying $7,632 more in interest expense. When cash flow is tighter then paying a smaller monthly payment makes total sense but we see this decision made on more of an emotional level instead of a budgetary one. We review their monthly business bank statements and cash outflow and know they can easily make the higher payment but they still go with the lowest payment option. We often advise to reconsider but the decision is an emotional one and their mind has been made. Business owners should carefully consider the impact of taking the longest term as this is a simple yet clear example of how it can impact your bottom line.