Have your cash and borrow, too

Have Your Cash And Borrow, Too

When Bobbie Marschall decided she needed larger quarters for her growing secretarial service, she also decided she didn't want to spend all of her cash on the venture. Instead of investing her money directly in her business, she placed it in a certificate of deposit (CD) with a bank, then used the CD as collateral to borrow money. She improved her credit rating and preserved her capital.

"I'm still making money on my money," she says. "It's like I'm paying myself back and paying a little to the bank. When I get through [paying off the loan], I'll have more money than I started out with."

This method of borrowing is called a savings-account loan (SAL). It is used often by owners of new businesses, primarily those who, like Marschall, want to establish credit while they preserve their capital.

Here's how a SAL works: You put cash in a CD with a bank or a savings and loan association, then take out a loan for the same amount. (Some lending institutions limit the loan to 90 percent of the CD value.) The CD is held as collateral, so you can't withdraw funds--even at maturity--until the loan is repaid. If you are unable to pay off the loan when the CD matures, you may extend the debt by rolling over the CD for another term. At that time, you may withdraw part of your funds if you have paid off part of the loan.

Harlan Fine, owner of Fine Instant Printing in Los Angeles, has used SALs, and he says: "It can be a smart way to use your money. As you pay off the loan, you become liquid. But you are tying up your cash, so you have to be able to do without your money until you can pay on the loan."

New business owners with cash may be reluctant to go into debt, but if they invest their own money in a business, they will not establish credit and they will use up their capital.

This puts more pressure on the business to produce income at the same time it is growing. In addition, because cash may be collected in relatively small amounts, these owners may find it difficult to pay for large purchase or a major expansion.

"I did not have one large sum when I started out, only small amounts coming in," says Caroline Cubbin, owner of In Bloom Again, a Brooklyn, N.Y., flower shop. "Now I may sell my business and use the money as collateral for a loan to start a larger flower shop in another location. There is so much more you can do with one large sum. I'll still have my cash [from the sale] earning interest in the bank, and I'll get a low-interest loan."

SALs are usually less expensive than conventional business loans. Current CD rates determine SAL rates, so if you invest in a long-term CD that pays more, your loan will cost more. Each bank or savings and loan sets its own policies, but you should expect the interest rate on the loan to be 2 to 4 percentage points above the CD rate. Note that the interest you earn on the CD helps offset the loan interest.

Many lending institutions offer flexible payments plans. Some lenders may require monthly payments on principal and interest; others may allow quarterly payments on interest only. Still others will require only one payment a year. So shop around until you find the payment plan best for you.

The primary reason for choosing a particular payment schedule is control over cash flow. You may have a lot of income and want to make monthly payments. This would cost you less in the long run because you would be reducing the principal and you would be charged interest only on the balance.

But businesses that depend on a few large collections each year can benefit from quarterly payments.

Annual payments are mainly for new business owners who need a year to get on their feet. This is the most expensive plan, because interest is charged on the entire loan throughout the year.

In addition to shopping for flexible payment plans, look for a lender who makes it easy to qualify for SALs. Because you are pledging cash--the safest collateral--and you are guaranteeing payment, the lender may not required any financial documents or credit history, may not restrict your use of the money and may not require profit reports on your business.

Other lenders may want to examine your business, may ask for copies of your tax returns and may check your credit history.

A most important question you should ask is what happens if you can't pay off the loan. Obviously, the lender will take the CD as payment, but how would that be reported on your credit rating? Some banks would consider it a bad loan even though you repaid it with cash from your own CD. Find out the lender's policy before you borrow. If the lender considers it a default if you pay off the loan with your cash, go elsewhere. Most lending institutions will give you a good credit report whether you make payments or forfeit the CD. Even if your business fails, you would have good credit.

If you decide to use a SAL, remember that you can tailor it to your needs. The right SAL will offer you easy credit, capital preservation and growth, low interest and a flexible repayment plan.

In addition to these financial benefits, there also may be a psychological plus. Laurie Williams, business development loan officer at American Pacific State Bank in North Hollywood, Calif., says: "If you take out a loan against your cash instead of spending it, there's a better chance of getting it back. You'll pay the bank back before you pay yourself back."

COPYRIGHT 1988 U.S. Chamber of Commerce
COPYRIGHT 2004 Gale Group