Should You Pay More in Interest?
Of course not… well… maybe. The answer may depend on cash flow.
GARY GERBER, O.D.
You want to borrow money to improve your office. Bank A’s interest rate is 5%. Across the street, Bank B’s rate is 6%. All things being equal, which deal is better?
Our knee jerk reaction causes us to equate “monthly payments will be less” with a more favorable situation. Why? For most, it’s simple arithmetic: If you pay less interest to the bank each month, whatever you’re not paying you get to keep. With the money you keep, you can buy groceries, go on vacation, buy a digital tablet or do whatever else you want. Right?
Well, not exactly.
Look at the terms.
In the example above, it’s likely that since the two banks are located across the street from one another, the terms of their loans differ. Usually, the difference is the payout length. A higher interest rate might actually mean a lower monthly payment, but you’ll need to make more of them. So, borrowing $50,000 at 5% for five years results in a monthly payment of about $943, while at 6% for seven years you’ll pay back about $730 per month. Of course, we’d like to pay less. But if we do, we pay $4,740 more (see Table 1).
Let’s continue down our muddying water stream and search for some clarity.
|TABLE 1 The $50,000 Question|
|Length of Payout||60 months||84 months
How will you use the money?
In our example, we found that if we pay the extra $213, we’re done in five years. If we don’t, we’re done in seven. Now, the question should rise from the muck — what would you do with the extra $213 per month? Would you indeed use it to pay for groceries, or buy a tablet or reinvest it in your practice? And if you did reinvest it, would that investment pay back enough money to offset the extra interest you’d pay?
For example, if you spent the extra $213 per month on a social media marketing campaign to boost your orthokeratology practice, would you net more than the extra interest ($4,700) through seven years because of the campaign? Or, if you spent another $1 an hour more in wages (about $200 per month) for a highly trained staff person, would that person generate enough income to offset the extra interest?
Go with the (cash) flow.
These examples address cash flow. For newer practices, or those who struggle to pay bills, cash flow is critical to success and often survival. Generally, it’s advised to secure a low payment initially, especially for new practices, provided you are fiscally responsible and stick to a careful budget. That way, any extra money you might have paid with the short-term deal will be invested back into your practice.
Other terms to understand
Many lenders offer a few months of either no payments or low payments early on. Of course, those get “tacked on” to the loan’s end. But again, these arrangements may help cash flow. Also, some lenders offer the long payout and provide for no prepayment penalties. That way, once cash flow improves, you might be able to pay extra on the high interest seven-year-loan, and pay it off in five years anyway. OM
DR. GERBER IS THE PRESIDENT OF THE POWER PRACTICE, A COMPANY SPECIALIZING IN MAKING OPTOMETRISTS MORE PROFITABLE. LEARN MORE AT WWW.POWERPRACTICE.COM, OR CALL DR. GERBER AT (888) 356-4447.
Optometric Management, Volume: 48 , Issue: July 2013, page(s): 90