Refinancing at today's microscopic rates can build you a cash-flow cushion that could save your bacon one day. What are you waiting for?
Interest rates are at lows you may never see again in your lifetime. Make no mistake: This is a gift. It's a once-in-a-generation opportunity to improve your cash flow by, among other things, refinancing your mortgage. I'm encouraging my clients to grab this chance whenever it makes sense for them.
As a business owner, however, you know full well that your business finances and personal finances are tied together. Whatever business debt you have is essentially personal debt (since you usually have to guarantee it), and whatever personal debt you have often affects your ability to finance your business. The same goes for cash flow. Reducing outlow on the personal side or your cash flow statement frees up cash for your business. This is where a shiny new mortgage comes in.
How Refinancing Can Help
Let’s assume that the economy or your business hits a rough patch, and your business requires a cash infusion. One of the easiest ways to free up cash for the business is simply to pay yourself less. All else being equal, the lower your mortgage payment is, the easier it is for you to reduce your pay to help keep the business going. That’s why I encourage business owners to seek out a mortgage with the lowest fixed payment.
Here’s an example. Assume you have a $400,000 mortgage and your financing options are to go with a 15-year mortgage at 3.25% or a 30-year mortgage at 3.85%. If you didn’t own a business, going with the lower interest rate 15-year mortgage typically makes the most sense.
But you need to consider the effect on cash flow. The 15-year mortgage has a payment of about $2,800 a month and the 30-year is about $1,875. The difference is access to about $925 a month.
To a business owner, the cash flow flexibility may be worth the extra interest costs. Why? Because of the perverse nature of credit access. The time you need credit most—that is, during a rough patch in the economy or your business—is also the worst time to go to your bank and ask for it. Indeed, during difficult economic cycles banks are more inclined to cut your line of credit than expand it. We saw far too much of that in the past few years.
The lower mortgage payment gives you some flexibility to reduce your pay and keep more money in the business. Plus, most 30-year mortgages give you the option of paying on a 15-year schedule. So you can prepay during good times and drop to the lower 30-year monthly payment whenever conditions worsen. But if you were to commit to a 15-year mortgage, you couldn’t adjust to a 30-year payment schedule without refinancing (if you even could refinance when you needed to—remember the perverse nature of credit access).
The Secret of Re-amortization
There’s another mortgage feature that might prove helpful, if you can find a lender that offers it. That’s the ability to re-amortize your loan if you make a large principal payment.
Here’s why this option is valuable. Assume you had several good years in your business and you decide to pay down your $400,000 mortgage by $100,000. With a traditional mortgage, your monthly payment doesn’t change, but you’ll end up paying the loan off faster because the principal amount has declined.
But if you were able to re-amortize the loan, now you’ve got a new mortgage payment based on a $300,000 loan instead of a $400,000 loan, which is going to result in a much lower monthly payment. And that will provide you with additional cash flow should you require it a few years down the line.
How common are mortgages with this option? You’re more likely to find them at a regional bank or lender that holds onto its mortgages. They aren’t common, but they’re out there.
The moral: Refinance now, if at all possible. This is too good an opportunity to pass up. But bcause your business and personal finances are often one and the same, consider getting a fixed rate mortgage with the lowest monthly payment. When times are good for your business, you can pay more. If they turn bad, that extra cash flow might just help save your business.
Disclaimer: Consult your individual financial advisor prior to making any financial decisions.
CHARLES FARRELL is a principal with Denver-based Northstar Investment Advisors and the author of the book Your Money Ratios: 8 Simple Tools for Financial Security. The Wall Street Journal called it “one of the best financial books to cross our desks.”