Getting the Right Bank Loan

This is probably the type of loan most Main Street business owners think of when they head to the bank looking for a loan. In its simplest terms, a term loan is repaid in regular payments over a period of time. Auto loans and home mortgages are both great examples. Amounts and repayment terms vary depending upon the amount borrowed and the credit worthiness of the borrower, but both loan types are term loans.

It’s Usually Buried in the Small Print

They call it “mouse type” in the biz. It’s the itty-bitty type at the bottom or backside of the page that only a mouse can read. It outlines all the terms and conditions associated with a term loan. This is true for any loan not just term loans, and it’s a good idea to read it and make sure you understand it. Unfortunately, it’s usually filled with a lot of legal jargon and the size of the type is actually designed to make it difficult to read. But regardless of your desire to gloss over it, ignoring the fine print can cost you a lot of money and heartache down the road.

Two questions you’ll want to answer in the fine print are:

Is your interest rate fixed or floating? A fixed rate of interest means the percentage of interest will never change over the term of your loan, regardless of the financial markets. A good time to take out a fixed rate loan is when interest rates are low. Floating interest rates fluctuate with the market. When interest rates are generally low, you will enjoy a lower interest rate on your business loan. When rates go up, so will the interest rate on your loan. So having an adjustable rate loan could be good or bad depending upon what happens with the economy.

Is it simple or compounding interest? It’s amazing how such simple concepts can be so confusing and expensive if you don’t fully understand them. In a nutshell, simple interest is calculated only on the principal amount. In other words, interest is computed on the amount of the loan that remains unpaid at any given time. The formula looks like this:

Although this is a very simple example, notice that in year two of the compounding interest, you must pay interest on your principal as well as on the outstanding $50 in interest due. It is expected that regular payments will be made over the course of the loan; the calculations would reflect a monthly payment schedule rather than a yearly payment schedule. Typically, in the beginning, most of the payment is applied toward paying the interest, with a smaller percentage going toward the principal. As the loan matures over time, this ratio changes and more of the principal is paid off with each payment.

 As you might guess, if you anticipate paying off your loan early, a simple interest loan is better. Principal and interest are paid off at the same rate. Because a compounding interest loan is weighted with more interest at the front end of the loan, it may feel as if you are being penalized for prepayment.

Could a Term Loan be Just Right for You and Your Business?

Goldilocks taught us that one size does not fit all, which is why a term loan might not be the right fit for your business. That being said, there are some great advantages to term loans:

• Immediate access: Most people are familiar with an auto loan or home mortgage. The entire loan amount is immediately available to purchase equipment, fund working capital, fuel growth, and so on.
• It’s like clockwork: Budgeting is a piece of cake. You can anticipate your payment and make sure your business allocates funds every month to pay the monthly obligation. There are seldom surprises.
• Nothing is arbitrary: Your bank will charge you the agreed-upon rate. There are no arbitrary-feeling interest rate hikes regardless of what’s happening in financial markets.
• The books are easy: Accounting entries for loan payments are straightforward and easy to reconcile. This isn’t an accounting nightmare.
• Slow and steady wins the race: This is a great way to establish or improve your company’s business credit. Making regular payments over time demonstrates your credit-worthiness to the bank for subsequent (and potentially greater) access to financing.

Despite some of the advantages of a term loan, it isn’t all peaches and cream. There are some disadvantages too:

• Change is hard: If you get in a bind, or for any reason need to change the terms of your loan, you will need to go through the process of applying and qualifying for a new loan. Waiting until you’re in dire straits to go through this process is not a good idea. If you have a good relationship with your banker, he may have ideas as to how to approach the bank before things go completely south (see previous chapter).
• You could be left holding the bag: If interest rates go down, you could be paying a higher-than-market interest rate for your loan. Make sure you can live with the interest rate and are willing to either bite your tongue or find another loan should rates drop.
• Another loan might not be an option: Even if you’re prepared to find another loan, some loans include pre-payment penalties that make jumping ship for a lower interest rate problematic.

A Line of Credit

Although most people are looking for a term loan, a line of credit probably comes in a close second. Unlike a term loan, a line of credit is a source of funds that you can draw against when the need arises. Additionally, interest is paid only on the amount of funds used. For example, if you have a $10,000 line of credit but access only $5,000 to purchase a new piece of equipment, you pay interest and make payments only on the $5,000 you used.

Although it’s not exactly the same, this type of financial instrument is not that different from how trade was conducted in the early days of banking when Italian, Dutch, and English bankers offered a line of credit to international traders buying and selling goods throughout the world. You might also be interested to know that this type of financing was once the most common currency in international trade finance.

Today, a line of credit comes in many different forms. The most relatable is your bank overdraft protection. I don’t think most people think of it as a line of credit, but fundamentally, when you overdraw your personal checking account and the bank covers the amount, they do it with a loan. It’s likely you have a fixed amount over which your bank or credit union won’t honor your checks. It might be $800, $1,000, or more. In reality, that’s a line of credit associated with your checking account.

One More Thing

Ultimately, the best time to apply for a loan is when you’re prepared. If “your ducks are in a row,” as my grandmother used to say, other timing considerations become secondary. In my opinion, your ability to repay the loan is the single most important timing consideration. With that in mind, I wrap up this chapter by covering the factors your banker considers as you prepare your business case. In other words, the reasons why you need the loan, how you’re going to repay the loan, and what you’ll do should something unforeseen happen:

• Projected revenue: Your banker will likely want to see that A + B = C. If he extends a line of credit or a term loan to your business, how is that infusion of cash going to impact your bottom line? For example, if you are borrowing to facilitate expansion, where will you spend the loan amount and what is your expected return? A small business owner I know wanted to expand into a new and bigger space. He wasn’t looking for buckets of cash; actually it was a rather small loan by most people’s standards. But the $10,000 he was looking for would allow him to lease a new space, and it included some cash for additional marketing to ensure they were also finding new customers. He could demonstrate a reasonable return on the investment and his loan was funded. A + B = C is what your banker wants to see.
• Projected expenses: You banker will also want to know the total cost of your plans. If you can’t justify your expenditure of borrowed money with a positive ROI (return on investment) that demonstrates your ability to repay your loan, you’ll likely leave the bank empty handed. The world of finance is a world of projections, assumptions, and best guesses as much as anything else. If you’re not prepared to show the bank what you expect to happen, the timing isn’t right.
• Having skin in the game: You read about this in an earlier chapter, but it bears repeating. You banker wants to know the total cost of what you want to do and whether you’ve invested your own assets—that you have skin in the game.
• If the market will respond: Your banker will want to know that this isn’t a crap shoot. Even when you’ve made some personal investment in this endeavor, if you can’t convince your banker that the market will respond and you have a reasonable chance of success, they’ll likely pass. Nobody likes to throw good money after bad, particularly your banker.
• Having a contingency plan: If things in the market turn south, what then? Contingency plans and risk-mitigation strategies resonate with bankers. If you can demonstrate that you have a plan should things go south, you’ll have a better chance of securing the financing you need. What’s more, it’s always good to imagine “what if?” scenarios when you’re looking to the future. It forces you to take off the rose-colored glasses and realistically look into your crystal ball.

Although it probably feels like the time is right when you don’t need the loan (and you could be right), don’t despair. Benjamin Disraeli, a British politician, writer, and aristocrat of the nineteenth century, said, “The secret of success in life is for a man to be ready for his opportunity when it comes.” In other words, be prepared for your visit with the banker.

Read More

Building a Relationship with the Bank

Many larger credit unions provide the same types of services that were originally provided only by banks (much to the chagrin of bankers, I might add). Although I refer to banks more often than credit unions in this chapter, most of what applies to one applies to the other.

My hope is that neither bankers nor those who offer small business services at a credit union will be offended by my offhanded use of the term “bankers” to describe them both. (However, I know that a couple of my credit union friends might have a thing or two to say about it.)

When my wife and I were first married, we were members of a small credit union that had only a few branches. The branch manager knew and trusted me. Whenever I needed a little extra cash, I could easily borrow a couple thousand dollars against my signature. Even though these types of relationships don’t exist much anymore, it doesn’t mean that building a good relationship with your banker is any less important.

 Over the years, I’ve seen countless ads from major banks in my area and around the country claiming that, unlike the other banks, their bank takes their partnership with small businesses seriously. In all honesty, over the years I haven’t known too many bankers who treated me as a personal associate, but I’ve had the chance to work with a few.

There are a lot of smart business owners who, for one reason or another, are part of the group Coleman is talking about. That’s why so many bankers focus on credit score, time in business, and annual revenues. Those criteria are important, but your character and experience is becoming more and more important to many bankers. You need to make sure you put your best foot forward in that regard, too.

 As mentioned earlier, most banks want a credit score of 650 or better, several years in business, and a fat bankroll before they’ll talk to you about a loan. However, there are some bankers who are looking for long-term relationships with business owners just like you.

Which Local Bank Is Courting Small Businesses?

As mentioned earlier, some banks are more interested in courting small businesses than others. Or, rather, some banks will be more interested in doing business with you than others. The trick is determining which banks they are. As promised, here are a few more suggestions to finding the right bank. Russakoff and Goodman suggest a few places where you might find banks that are courting small businesses. Treat your search for a bank much like a prospecting exercise. Start with a list, do your homework, and prepare to ascertain the information noted previously. Then narrow down your list to a few banks that look like a good fit, and interview them all before you make a decision. I call this the “Beauty Pageant method” and, much like the Miss America Pageant, the interview carries a lot of points. Here are some ways to build your list:

• Talk to your business peers (Russakoff and Goodman suggest this might be the best place to look, and I agree)
• Ask your biggest customers where they bank 
• Ask your suppliers, vendors, and other professional service providers where they bank
• Contact applicable trade associations 
• Scour online resources such as ibank, sba.gov, LinkedIn, Lendio, or whatever pops up during a simple Google search

Never Forget: Banking Is a Business

While you’re standing in the lobby waiting for someone to help you, it’s easy to forget that banking is a business and you are a potential customer. I’ve met with bankers who tried to make me feel like I was fortunate they were even talking to me. The truth is, regardless of how big the bank is or how small your business is, one of the biggest challenges facing many bankers every day is finding new customers.

As mentioned earlier, most bank marketing is old school. When looking for new business, many bankers rely on a referral network of CPAs, the Chamber of Commerce, insurance agents, and traditional marketing like billboards, radio, and the events they sponsor. When you go into the bank to open an account or to apply for a loan, they are looking for good customers every bit as much as you want to be one.

Remember, even though you are going to be the bank’s customer, you need to make sure you put your best foot forward. I don’t think that means you need to wear a suit and tie or your Sunday best, but you do need to look professional, have your financial records in order, and be ready to make them salivate to do business with you.

Read More

How do I Know if it's Better to Buy a Home or Continue Renting?

Perhaps one of the easiest ways to determine if it’s better to buy or rent is to sit down and calculate the financial advantages of owning versus renting. This is commonly done online with a ‘‘rent versus buy’’ calculator found on the Web.

How do I Know if it's Better to Buy a Home or Continue Renting?

These calculators compare your current or probable rent situation with a projected home ownership number. They’re easy to find. I ran a Google search for the term ‘‘mortgage and calculator’’ and retrieved 6,100,000 websites that had those two terms in combination.

But the kicker is that these calculators rarely will tell you, ‘‘No, it’s not a good idea to buy.’’ That’s because of the tax benefits of home ownership. The interest and property taxes associated with a mortgage are generally tax deductible. You can deduct them from your gross income when you file your taxes. With rent, you can’t.

Yeah, I know. When you’re a renter you don’t pay property taxes or mortgage payments. Instead you give money to someone else for the privilege of living there. But you can’t write off your rent. It’s just that. Rent.

When might a ‘‘rent versus buy’’ calculator suggest it’s better to rent? When you intend to own your next home for only a year or so.

Buying a home incurs other expenses, such as money for the down payment, property taxes, and hazard insurance (which is much higher than a renter’s policy). Many apartment complexes pay your electric bills along with water and other utilities. When you own, you pay all these expenses. Owning a home with all its tax benefits doesn’t outweigh the acquisition costs to buy the home if you’re only going to own it for a short period. Short term, rent.

Longer term, buy. Are your rent payments the same or less than what a mortgage payment would be? Depending upon where you live, they may be the same. Especially if interest rates are relatively low.

Let’s say you’re renting a nice 3,000-square-foot, three-bedroom home close to schools in a friendly neighborhood. You might be paying $1,800 each month in rent. A similar three-bedroom home might cost $150,000. If you put 5 percent down to buy the home, your monthly house payment, including taxes and insurance, would be close to $1,200 using a 30-year fixed rate at 7.00 percent.

If rent payments in the area in which you want to buy are near what a mortgage payment would be, it makes sense to buy. If you can save $600 per month and you also get to write off the mortgage interest and property taxes, then it’s truly a no-brainer.

Another reason buying is generally better than renting is simply a matter of appreciation and equity. When you rent and property values increase, your landlord will probably raise your rent again.

And, of course, each time you make a rent payment you’re not increasing your equity in anything; you’re just helping your landlord increase his stake in your house or apartment. I’ll give you an example.

Your rent is currently $1,000 per month, and you’re thinking about buying a $150,000 home. If you put 20 percent down and borrow $120,000 at 7.00 percent on a 30-year fixed rate, your principal and interest payment are about $800 a month. Let’s also assume that property values are increasing in your area by about 5 percent per year. What’s the situation after two years?

If you rented, you paid someone else $24,000. But if you owned and itemized your federal income taxes, you likely deducted over $16,600 in mortgage interest on your income taxes. You also paid your loan down by over $2,500 while at the same time increasing your equity position in the house by nearly $18,000.

Now you see why those calculators always tell you to buy a home.
Through all of these calculations, remember the real reason for buying: You buy a home because you want to. Because you like the place. It’s your home. A home is one of the largest single financial commitments someone can make. And while I agree with that statement, let’s not go overboard here. Buy a house because you want to, not because some calculator told you so.

Read More

When is a Good Time to Buy a Home?

Have you ever heard a real estate agent say that it’s a bad time to buy? I haven’t. It’s either ‘‘The market’s hot, buy now before prices go up even further,’’ or ‘‘It’s a buyer’s market right now, make an offer while the deals are good.’’ Come on, agents need to make money, too, right? A good time to buy is when you, and only you, decide that it’s right.

TELL ME MORE
When I moved from San Diego, California to Austin, Texas, I knew I wanted to live in Austin, but I really had no idea about where to live within the area. Austin’s a great town with a lot going on, but I knew nothing about the area’s traffic, schools, or where the best dry cleaners were. I know that there are plenty of tools out there to help make decisions and there are many relocation experts that can help.

But I picked out a house to rent for about a year instead of buying. I wasn’t ready to buy. Why? While I knew Austin, I didn’t know Austin.

I couldn’t have known certain things without living there. I also knew that if I bought in Austin, I would most likely soon be moving out of that house to the area where I determined I really wanted to live.

It worked out great. Now when I go to work in the mornings my commute is quick, the kids are in a blue-ribbon school district, and we’re close to downtown while in a nice, quiet neighborhood. Lucky me, right? Maybe, but I don’t think I would have been so lucky if I had tried to buy a house in a city right off the bat without living there first. Life’s like that.

Sometimes just reading a book about something doesn’t make it feel real. Living it does. Is there something that tells you, ‘‘Wham! Buy a house!’’? No, of course not. But perhaps one of the best ways to know if it’s a good time to buy or not is the fact that you’re even thinking about it in the first place. It’s a good time to buy if you’re ready, and a bad time to buy if you’re not. Don’t get pushed into home ownership.

Too many people get caught up in real estate valuations, home price cycles, the number of homes listed, buying in the winter instead of the summer, and so on. While these are all useful considerations, they shouldn’t make that much of a difference when all is said and done. Yes, it’s easier to buy in the summer and move if you have kids and you want them to start a brand-new school at the beginning of the new school year. Yes, home prices might be a little softer in the wintertime than in the spring or summer because of seasonal demand.

And yes, it might be a good time to buy a home because the market is soft and values will certainly appreciate. But don’t get caught up in all of that. At least not to the point of paralysis. There is no right answer. Certainly, these things should be taken into con sideration at some point, even more so if you’re a real estate investor who studies market trends and buys and sells homes for income. But if you’re just looking for your first home, don’t get bewildered by such facts.

Buy a home because you want to, rather than for an investment.
Buy a home that you can call your own. Begin saving for the future by building equity. But buy from the heart while using your head.

Don’t buy because some real estate guru told you that you could make millions in real estate. Bookstores and late-night infomercials have enough on real estate investing. If you’re reading this book because you want to become a real estate tycoon, you bought the wrong book.

Read More

The Procedure of Mutual Guaranty Loans

As a subsect of loan financing, Mutual Guaranty Loans are subject to a procedure of issuance very similar to that for regular loans issued by commercial banks, including application, review and approval. The major difference for Mutual Guaranty Loans lies in the pre-application process. Before applying for a Mutual Guaranty Loan from banks, the applying firms must form a Mutual Guaranty group and then complete the application for the loan as a group. More specifically, the entire procedure is as such:

1.  Three or more companies come together to form a Mutual Guaranty group. Each firm within the group has to negotiate with the others in order to determine the quota of the respective loan amount that each firm needs. Then, the group will submit their collective loan application to a commercial bank.
   There is no unique or singular way to form a group—it can be formed by themembers of certain credit union, formed freely, independent of any existing organizations, or it can be formed with the guidance of government, industrial organizations, or even banks.
2.  The formed group will submit the loan application to the bank, either at the counter or online.
3. The bank will conduct due diligence reviews for each individual member of the group, and determine if the requested loan will be granted.
4.  If the application is approved, all the members of the group need sign the legal documents with the commercial bank, and agree to jointly bear the responsibility of repayment of the loans.
5.  All members of the group need to set up an account in the bank in order to deposit the required guaranty reserve.
6. The bank will issue the loans.

For example, five manufacturing SMEs would like to apply for a loan, and all the firms have stable customers and incoming cash flow. When the market is booming, the firms may experience an increased need to finance their working capital.

However, due to inadequate collateral, none of these 5 firms can obtain the loan from bank individually. In this case, these 5 firms can form a Mutual Guaranty group with a pre-determined quota and a guaranty agreement, and then apply for the loan from a bank.

If the loan, say, RMB 25 million, is approved after due diligence, and the quota was predetermined to be equally split, then the loan will be divided by 5, and each member will receive 5 million. Each member will also need to pay 20 % of guaranty reserve, with similar shares of borrowed funds.
Mutually Guaranty Loans

Read More