My wife received one of those promotional check offers on her business line of credit today. She’s a wedding photographer and owner of Megan Hardre Photography. I’m sure you’ve seen the offer though: 3.99%* for 12 months! Convenient! Flexible! Write yourself a check today!
Being a CPA, I always read the fine print attached to the asterisk and these offers are just never as good as they initially sound. I thought I’d take the time to calculate exactly how much interest a business would really end up paying if it utilized this “line of credit” under a couple of scenarios. I’ll give you a hint: the hidden killer is in the fees.
Let’s take a look at the fine print.
…For each check posting to your Account, we will assess a Promotional Discount Transaction Fee (FINANCE CHARGE) equal to 3% of the check ($5 minimum).
Well, that’s not so bad, you say. A little transaction fee will at least be offset by the low, low interest rate, right? Maybe, but probably not. A 3% fee sounds an awful lot like an additional 3% interest and since this offer is good for exactly one year we can just add the two together to get a real rate for borrowing money under this program and paying it off as late as possible (before the rates rise, of course). If a business borrowed $1,000, paid $30 in fees (3% * 1,000) and paid it off in a year, there would be $39.90 in interest (3.99% * 1,000). If you’re paying $69.90 for the privilege of borrowing $1,000 for a year, that’s equivalent to a 6.99% real interest rate ($69.90 / $1,000).
Still not a terrible interest rate for a line of credit, but what if you pay it off sooner?
If you paid it off in 6 months, that $30 fee turns into the equivalent of a 6.00% interest rate (3% / 0.5 for half a year). Now you’re paying 9.99% annual interest when you add back in the 3.99% interest already being paid. That sure grows quickly.
Let’s max this program out and assume you borrowed the $1,000 and paid it off in just one day. 3% paid for the privilege of a single day’s worth of credit is a staggering 1,095% annual interest rate! (3% fee * 365 days in a year) That means if you were to borrow that same $1,000 each day and pay it off a day later for one year you would pay $10,950 to essentially borrow $1,000 for just one year. And that isn’t even counting the fabulous 3.99% interest they’ll charge you on top of those fees.
Businesses are faced with these kinds of hidden interest costs on a daily basis. Discounts for paying vendors early and penalties for paying vendors late are among the most common examples. Overdraft fees due to poor cash management, payday and bridge loans from loan sharks, points and closing costs to refinance, and profit sharing with investors are all components of the real interest cost of borrowing money for a small business owner. If the real cost of capital is more than what you can get somewhere else or, God forbid, more than the profit you’ll make, it isn’t worth it. Make sure you do your homework with your accountant before accepting the next “deal”.
