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Loan options for startups
Dear Small Biz Adviser:
My wife and I are opening a restaurant.
Should we look into a small-business loan or use the equity in our
house and take out a second mortgage? Is there such a thing as a
government small-business loan?
Keith
Dear Keith:
Two critical agendas are in flux at this time: Federal Reserve
decisions on the prime interest rate and congressional hearings
on the coming fiscal year's federal budget. What happens in both
of these areas could affect your choice of financing.
Over the last 18 months or so, the Federal Reserve
has reduced its lending rate to banks to a point that mortgage interest
rates have been at their lowest since 1965. However, Bankrate.com
and just about every other business and financial news source has
clearly indicated that rate reductions are over. Despite some conflicting
data, it appears the recession is nearing its end and manufacturing
orders and retailers' inventories are on the rise.
In this context, I have witnessed over the last three
weeks consecutive increases in 15-year fixed mortgage rates at a
local bank. The same rate jumps are happening nationwide. Meanwhile,
home equity lines of credit remain low. However, these credit instruments
are subject to adjustments. What may be 5.5 percent today for that
line of credit may rise above 8 percent or more in 12 months.
Regarding government loans, I suspect you refer to
the famous Small Business Administration loan programs. With very
limited exception, the SBA does not issue loan proceeds directly
to the borrower. It provides "guarantees" to the lender
that should the borrower default on the loan, the SBA will cover
75 percent to 90 percent of the defaulted proceeds, depending on
the use of those funds at the time of issuance and the specific
loan guaranty implemented.
What makes the SBA a hot topic today is consideration
by Congress to reduce the amount of guaranteed subsidies for the
7(a) program, which is implemented in small business loans by the
overwhelming majority of commercial lenders nationwide. The program
may lose as much as $5 billion dollars in funding, which represents
approximately 50 percent of this year's budget. That being stated,
I do not hesitate to advise my clients that if a 7(a) loan is in
their plans, make the move as soon as possible. Competition will
increase, and commercial lenders using that program will likely
raise the stakes (by reducing their risk factors) when applying
the program to small-business loan applications.
So where does all of this leave you? If interest rates
are critical to your cash-flow needs, I suggest one or more of the
following options:
- Use the equity in your house to secure a home equity
line of credit while the interest rates are low.
- Refinance the outstanding balance on your mortgage
and add a cash-out option for the amount needed in the business.
Of course, this serves your purpose only if the rates offered
are equal to or less than the existing rate on the mortgage.
- Approach the local commercial lender of your choosing
as to whether it offers 7(a) loan programs. Naturally, you'll
want to know the current rates on conventional commercial loans.
Regardless of your choice, get the advice of your
bankers first. They always want to help you make more money. That
means they will make money. Likewise, they don't want you to lose.
In any case, I would begin putting together a business
plan that provides you the tools and timetables for implementation
of loan proceeds for the business.
I wish you well.
-- Posted: March 21, 2002
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