Capital Needs: To Borrow or Not – Initial capital is a problem for many who want to start their own business. To those who have no money, they borrowed it from their relatives, friends and neighbors, and to financial and lending institutions in their area. But first time business loan is not easy, though.
In many cases, many of them borrowed without thinking of the cost, the payment terms of lenders are affordable so that the borrower does not bother to compute the actual interest being charge or they don’t know how to compute.
There are many types of lending operations. Here are some terms and the effective interest rate of each:
1. There is what they call “5-6”. In this case, if one borrows, says P5,000 in the morning, the borrower has to pay P6,000 at the end of the day. Effectively, the interest is P1,000 over P5,000 or 20 percent in one day or the equivalent of P7,300 percent per year (365 days).
2. Then, there are those who borrow P10,000 for five months and pay interest of P300 each month or 3 percent per month or P1,500 for the five months. The entire P10,000 is due at the end of the five months. The effective yearly interest rate for this kind of loan is 36 percent per year (1500/10000*12.5).
3. Some borrow P10,000 for five months and only get P8,500 in cash. Then, they pay P1,000 every 15th and 30th of each of the five months. Actual cash interest paid is P1,500 but at the start of the period. The effective interest rate of this is 42.3% per year (1,500/8500*12/5).
4. There is another variation where the entire P10,000 is received and payment is over 26 weeks. P1,000 on the 15th and 30th of 6 months (24 months) and P500 on the 25th and the 26th week. Cash paid is P13,000 and the effective interest rate of this is 55 percent per year (3000/10000*12/5).
5. Again another way where P10,000 is received upfront and P600 is paid every 15th and 30th of each month for 10 months. Cash paid is P12,000 and the effective interest rate is 24 percent per year (2000/10000*12/5)
Are these fair interest rates or are they too expensive? My standard reply is that there is no such thing as an expensive loan provided you use the loan proceeds to generate income much higher than the cost of the loan.
For example, if you borrow P5,000 of “5-6” but you are able to earn P2,000 from the business in one day, then, the P1,000 interest you paid was worth it. You would not have been able to earn the net P1,000 if you did not borrow the P5,000 in the first place. This is good debt.
When you need to borrow for needs, you can only try to get the lowest interest rate possible. Needs are expenses that you cannot do without such as daily subsistence, food, utilities, medical needs and others that cannot be postponed.
However, borrowing for wants is a big no-no! It is like buying the item that you want but do not really need and cannot afford at very high price. When you find out that you paid too much for an item, don’t you feel bad? It is the same effect when you borrow at a high interest rate for something that is optional and that you can postpone buying when you have the actual cash.
For those who do not have to borrow and have the money to lend, these are the same options open to you. However, you must remember that you have the following considerations and risks:
· Psychological effect of lending to people who are so hard-up.
· Not being paid on time.
· Not being paid at all.
· Being branded as someone who takes advantages of others. This can be unfair because you are actually providing service to those who need help.
(Source: Francisco J. Colayco) www.colaycofoundation.com