Is a second mortgage business loan too expensive? Do the maths
A second mortgage business loan is too expensive only when the money earns less than it costs. HomeSec founder Paul Stone's test is simple: if the benefit of getting the funds quickly outweighs the cost, go ahead; if it does not, walk away. The figure to weigh is the profit you would lose by waiting, not the rate on its own.
5:06 “Short-term business loans are too expensive.” Paul Stone hears it all the time, and in the video above he takes it to a whiteboard to show why it is the wrong question.
The cost of a second mortgage is real, and you should know it to the cent before you sign. But on its own it tells you almost nothing. A loan is worth taking when the money makes more than it costs, and the only way to know is to put both numbers side by side.
The deal that kept going to a competitor
Years before he founded HomeSec, Paul owned a group of high-volume, low-margin shoe stores. Importers and manufacturers would ring with an offer: the last ten thousand pairs of a line, at a fraction of the usual wholesale price, on one condition. The money had to move from his account to theirs, now.
Sometimes the cash was not in the business account. Sometimes it was, but spending it on stock meant not paying twenty staff or the rent on the shops. So he did the responsible thing and let the deal go, knowing exactly where the stock would end up: with one of his competitors.
“If I missed their call, I’d miss the opportunity.” — Paul Stone
Paul’s worked example
On the whiteboard he runs the numbers on a pair of shoes, with round figures chosen for the exercise.
- A pair normally costs $60 wholesale and sells for $120.
- The importer offers the last 10,000 pairs at $20 each, but only if the whole lot is paid for straight away.
- That takes $200,000, and it has to be in the account by tomorrow.
Bought at $20 instead of $60, every pair carries $40 more profit than usual. Across 10,000 pairs that is $400,000 of extra profit, on top of the margin the shoes would normally make.
Now set the cost of a three-month loan for $200,000 against that. Whatever the letter of offer says, it is a small fraction of $400,000. Paul then halves the benefit, assuming he would cut the price to move that much stock quickly, and the deal still comes out comfortably ahead.
The loan was never the expensive part. Missing the deal was.
Why the bank route loses the deal
The alternative Paul describes is the one most business owners know. Ask the bank and be asked for an updated business plan. Book a valuation on the property. Try a cash flow lender and get knocked back for being too highly geared. By the time any of it comes good, the importer has sold the stock to someone who could pay that day.
A property-secured business loan works differently. HomeSec looks at the equity in real estate you already own and the purpose of the loan, not your financial statements or cash flow records, and can fund in as little as 24 hours.
The test Paul gives brokers and clients
“If the benefit of getting the funds quickly outweighs the cost, go for it. If for some reason it doesn’t, don’t do it. It’s that simple.” — Paul Stone
That cuts both ways. If the opportunity does not clear the cost of the money, the right answer is not to borrow, and a good lender will tell you so. If it clears it many times over, as Paul’s shoe deal did, arguing about the rate while the deal walks out the door is the dearest choice on the table.
How to run the sum on your own deal
- Write down what the money will earn. Extra margin on discounted stock, a contract you can now accept, a property you can now settle. Be conservative.
- Get the full cost in writing. Interest, fees, and what happens to unused interest if you repay early. Our fee checklist lists every question worth asking any lender.
- Put a price on waiting. If the cheaper loan takes six weeks, what does the business lose in those six weeks? The cost of delay calculator does this part.
- Compare benefit with cost, not cost with cost. Two quotes side by side only tell you which loan is cheaper, not whether either is worth taking.
When opportunity knocks, Paul’s point is that you need to be able to move.
Reviewed by Jason Brockmuller, Joint Chief Executive