What Rate? The Quality v Price Challenge
There are a couple of expressions that always cross my mind when I am contemplating an important decision, particularly one involving money. The first is an old Latin saying favoured by lawyers of a certain age. Caveat emptor is Latin for “Let the buyer beware” (from caveat, “may he beware”, a subjunctive form of cavere, “to beware” + emptor, “buyer”).
The other is a more recent advertising slogan that I think rings very true. This was first attributed to Sir Frederick Royce who, with Charles Rolls, founded the Rolls Royce company. Frederick made this statement in relation to his company’s products but I think it is true of most purchases of goods or services. He said that the quality will remain long after the price is forgotten.
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I think borrowers should reflect on both these pearls of wisdom when selecting a bank to finance any purchase, but particularly business purchases. Too often we see borrowers focusing completely on rates with scant regard for the fact that they are likely to have a relationship with their chosen lender over the medium to long term. During that period the relationship and cost of doing business with the lender may well change and not always for the better. We strongly recommend that borrowers step back from interest rates as a sole arbiter of the relative merits of a finance package and look at the deal in its entirety. This should include reasonable assumptions around where the bank is heading and what their medium term view of the transaction is likely to be. We certainly work with our clients to ensure that all possibilities are taken into consideration.
The first fundamental consideration is the reliability of the funding and the reliability of the pricing. Banks make money predominantly through fees and interest charges. Imagine if you chose a bank, settled the deal and then had the base rate or monthly loan fee go up. That’s exactly what happened earlier this month when the banks decided to lift business and commercial base rates for many new and existing clients. The banks cited increased capital costs which is something we have been warning our clients about for more than 12 months. Banks will also cite the need to make additional interest margins on so called risk and return models. That’s fine but beware the lender who prices for risk but doesn’t take any!
The second consideration is loan term. Some banks provide short loan terms of say 2 or 3 years to keep interest rates low. It’s called capital matching and it allows banks to lend at lower rates because the funding commitment to the borrower is essentially short term. Many borrowers think this is just an initial term and the loan will simply carry on. Not true. The loan will actually expire at the end of the term and the borrower must re-apply for the loan. There can be new loan fees and valuation costs. Imagine if you chose a bank based on an interest saving but then had to stump up a new loan fee and valuation costs every two years. It’s not just the cost either, it’s the hassle and the potential for your bank to pull the rug out from under you and not need a reason to do so. Thankfully not a regular occurrence but certainly a consideration when choosing a lender.
The third consideration is flexibility. You may get a great rate and some form of interest only period but what happens if your bank is not flexible and insists on P and I loan repayments after only a year or two? Those principal repayments may have the effect of decreasing tax deductable debt expense right offs or squeezing cash flow and not allowing you to make those tax effective contributions to your super fund. Suddenly that cheap rate isn’t looking quite so good any more. What about offset and redraw facilities? Variable rate to fixed rate options? Any costs involved? These are all questions worth asking.
Finally there’s service. The fact is that in my experience most people expect great service but few are prepared to pay for it. Banks are like any other business, they are trying to make a profit. The reality is that the bank with the lowest operating costs will sometimes have the sharpest rates and the lowest fees. The reason the bank can offer the apparently great deal may be because there are very few staff to process, approve and document your application. The low rates may seem great but if you fail to meet your finance approval obligations after spending thousands on legal and accounting fees then it’s pretty much all for nothing. Of course, if you engage a broker team such as ours to manage your finance application then the dramas that can come about through poorly resourced lenders can be largely avoided. We work with chosen industry specialists in the banks who have proven track records in great service and reliability. Do they always get it 100% right? No, but we are all only human. The difference is that the bankers we have developed long term relationships with work hard to deliver and work even harder to sort any issues. They also have credibility with their credit departments and make no mistake that can make all the difference, particularly if we are asking for something a bit out of left field or if times get a bit tough.
In summary we would suggest that while price (interest rates and fees) is important it is simply part of the broader consideration of the most appropriate financier for your particular transaction. Here’s a thought. If, in two years’ time, your bank demands a new valuation (at your cost), decides you or the industry you are in is riskier than they thought, puts you on P and I repayments, smashes your cash flow for tax and retirement planning and all your calls go to a call centre will you think back with fond memories of that great rate? If you have a finance broker you simply drop the problem on them. Their job is to be with you for the life of your loan and where necessary take up your cause with the bank you are using. Here’s another tip. Refinancing should be a last option, not the default first option setting.
Lastly, a word from an insurance salesman I know : When you arrive home and find your house on fire your first thought should not be “Thank god I have such cheap insurance”!
Mike Phipps F Fin
Director | Phippsfin Pty Ltd
ACN 139 124 673
Australian Credit Licence 364314