Every business at some point in its operating cycle will require some form of finance to pay its short term indebtedness or to fund new projects or business plans, or to acquire operating assets. Individuals at some point in their life may also need bank loans to help fund the purchase of a car, mortgage for a house or buy house hold appliances.
- You need to formally apply to a bank for a loan – When most people think of approaching a bank for a loan, they commonly ask for a business plan. However, not all businesses require a business plan. But all loans must require that you apply to the bank formally as such it is important that you are able to articulate your needs in your application letter.
- Banks charge interest on a per annum basis and they are not fixed– Banks do not charge interest rates per month but per annum. What this means is that when a bank offer a 20% interest on a loan it is per annum and not per month. For example, when you apply for a loan of N1million for a 3 month tenor at an interest rate of 20%, your interest will be N50, 000. Which is 20% of N1million apportioned for just 3 months out of the 12? However, it can actually be lower depending on how often you repay the principal. Meaning if you repay N300,000 at the end of the first and second month and N400,000 for the third month your interest will be 20% of N1m for the first month =N16,667. Second month will be 20% on N700k for one month= N11, 667 and finally N20% on N400k for one month = N6, 667. The total is now N35k. The interest rates offered to you is also not cast in stone as banks often have a caveat in the offer letter that allows them to increase the rate whenever they feel the market conditions require it.
- Different banks offer different interest rates and terms and conditions – Just the way the price of goods and services differ in the market so does the interest rates and terms and condition banks offer. Whilst some might favor you in terms of lower interest rates they might offer shorter repayment period. This takes me to the next point;
- Never ignore the terms and conditions – When gives you an offer letter they always include a set of “Other Terms and Conditions” or “OTC”. Usually, they differ from the conditions like collateral, interest rate, tenor (Terms and Conditions or TC) that most people prefer to look at. The issue however, is that when a loan goes bad and a bank takes you to court it is not the TC that often matter. The OTC is probably more important as it typically contains those issues that determine what the bank can do in the event of a default.
- Banks always ask for collateral or some form of security – Banks no matter the type of loan you ask for will ask for some form of collateral. It could be a landed property, asset or even your personal guarantee. Sometimes they remember to register claim to these collateral in the court and sometimes they don’t. When they don’t they are at risk to loosing claim to the asset in times of default. But don’t be fooled the court may still recognize an encumbrance even if it isn’t registered.
- Defaulting on repaying your bank loans when their due doesn’t mean the bank will take over your business – Yes, banks like to avoid the court as much as you do and quite frankly want you to succeed because your success and theirs is directly proportional. If you can’t pay back all of your loans, it is better to pay a portion of it that you are able to than not pay at all. Judges often take cognizance of that which positively helps your case. So when you default in repaying any portion of your loans endeavor to approach the bank and seek a new deal
- You can always attempt to refinance or restructure your loan – Following from above; you can always approach your bank to restructure your loans if you think the current terms are not favorable to you. And it is not also when your loan is bad that you can approach a bank. You can also approach them when your business is doing well and you are servicing your loans promptly. Businesses are such that the owners must constantly seek ways to improve its operational conditions you cannot just rest on your oars. Refinancing your loan involves approaching another bank to take over your existing loan as a new lender. You should utilize this option when the new bank offers your better T&C.
- You can ask your bank for a moratorium – A moratorium is simply a bank permission to a borrower to suspend repayment of principal for a period of time. Because some business ideas require time to start making money despite borrowing from a bank, it makes sense to give the business some time and not burden it with huge cash outflows that it could better use in growing the business. Banks recognize that and will often allow borrowers a period of grace (one month, three months, one year etc.) where they only pay interest and resume paying interest and principal at the end of the moratorium.
- The biggest threat to defaulting is not your interest rate but your Debt Service Coverage Ratio (DSCR)- Imagine two guys Mr A and B each borrow N1million but with Mr A told to repay over one year and Mr B over N3 years. They both get charged 20% per annum interest rates and will repay principal and interest at equal installments. Mr A will have to pay a total of N92k every month for one year till the loan is repaid whilst Mr B pays N37.1k every month for the next three years. Now assuming they both generate cash of N100, 000 every month in their business who do you think will go default sooner should there be a sudden drop in revenue within the first year? Certainly it is Mr A, even though he pays less interest (total of N111.6k) compared to Mr B (N337.8k) over three years. This is because Mr A has a DSCR of 1.09x compared to Mr B with 2.7X. Provided Mr B’s business earns a return on his investments that is over 20% he almost sure to make a profit despite paying higher interests.
- Banks have hidden charges – Apart from the interest rate bank charge, they also charge you fees and C.O.T. But off course we are familiar with these. However, banks also have other cost which they mostly do not tell you when you apply for a loan. For example, they deduct taxes whenever they charge you C.O.T or WHT when they are paying you an interest. They also charge you punitive interest rates whenever you default in payments even though your loan agreement provides less punitive rates for such. It is important to always ask your accountant to conduct a monthly spot check on charges when they prepare bank reconciliation reports.
