Since interest rates are extremely low, most business owners think putting equipment on a line of credit is a good idea….it’s simple to do and doesn’t appear to entail much risk. However, unless you have plans to pay off your line within the next few months this mindset can drastically affect your ability to expand.
Interest rates are forecasted to rise dramatically in the next few years due to the massive debt our government is in. When you tie up your line of credit you are taking a large gamble on either being able to pay back your line quickly or betting that interest rates won’t rise. A more prudent way to fund the growth of your business is to lock in as many fixed payments as possible over as long of a period as possible. Whether it be an equipment lease or loan make sure the payments are fixed to protect your business from rising interest rates. Save your line of credit for emergencies only ie. if your boiler goes out and you need a quick fix.
A perfect example is a client of mine that utilized their line of credit a year ago to purchase $500k in equipment. They used their line since it was the easy thing to do and interest rates were cheap. The problem is that although interest rates are cheap, their bank accelerated the terms on the line of credit making their monthly payment jump from a few thousand a month to over 20k a month. Now they are in a bind, they can’t refinance because their ratios are extremely leveraged and they appear to carry too much short term debt. In addition, their line of credit has a blanket lien on all the company assets so if they end up defaulting they lose their commercial building as well as all of their equipment.
Senior Account Manager, American Capital Group