Have you considered borrowing the maximum amount of money allowed from a bank or financial institution? Well, let me put this politely, “DON’T”! For a number of reasons, I would always borrow the minimum amount and here’s why.
Recently, I advised a business buying a commercial property to put down as much cash as possible. To my dismay, they did not agree, preferring to hold their cash and borrow as much as possible. Was this not a strange decision? Imagine it was you who had $1 million in cash and wanted to buy a $1.5 million property. What would you do? Look at this equation.
The cash you hold may be earning about 1% net (after tax deductions) from bank interest. If you put down $500,000 and borrow $1 million you will pay, let’s say, 5% interest. Essentially, you are borrowing your own money and paying an extra 4% to use it? Does this make sense?
In addition, your cash flow is committed before you get any of it!
Now, imagine if your business has a down turn and cash income is lower than anticipated. No doubt, this will cause difficulty in making the repayments. And what will l result from such delinquency?
Pressure from the lender, possible penalties for late payment, or worse, being forced to sell the property as the lender wants his money back.
If the worst happens, the lender will look to sale, which will allow him to reclaim his losses. And with that, you would have paid for years and have nothing left to show for it.
However, if you had put down the extra $500k, you would have the majority shareholding with a great opportunity to re-finance if needed. Also, your cash flow income would be significantly improved.
Don’t use the common excuse that if I borrow, I get a tax break on the interest! Yes, you will but only if you have profits to set them off against. Surely, this cannot be the best reason to borrow money and increase debt and reduce cash flow?