EIDL REPAYMENT: Pay According to Terms or Accelerate

Was your company one of the 3.9 million that received, on average, a $100 thousand EIDL, out of the total $378 billion borrowed to survive COVID-19?

If so, you should have begun repaying your 30-year, 3.75% loan from the SBA in late 2022 or early 2023.? If you’ve been paying your loan according to terms, 100% of your payments have been applied to the accrued interest on your loan, and you still have 1 or 2 payments left before you begin paying towards the principal on your loan.? I hope you have been monitoring your payments on your MySBA Loan Portal .

I’m discussing this accrued interest topic because there was some “fine print” in your EIDL papers that you may have missed.? From the date you received your EIDL, your loan began accruing interest at a 3.75% rate, but the SBA provided up to a 30-month deferral period before you were required to begin making payments.? Which means for about 18 months you’ve only been paying interest on your loan.

Why does this matter?? Because from the date you began making payments, you agreed to pay-off your loan in 30 years.? That means that if you continue to make payments according to terms, you’ll still have about 18 months of payments remaining when your loan comes due in 30 years (the effect of the deferral period) and you’ll have a balloon payment equal to 18 payments.

Should you be worried?? I wouldn’t be, there’s plenty of time to make up these payments (just increase your required monthly payment by 5% and you’ll be fine).

But this whole EIDL situation brings up some important information about debt management for small businesses.? Specifically, when should debt be paid off early, when should you pay according to terms, and how does sufficient working capital affect a business?

Leverage

Let’s start with a Finance 101 issue that many small business owners may not understand.? Leverage.? In financial terms, "leverage" refers to the use of borrowed capital or debt to increase the potential return of an investment.? In other words, if the “cost of funds” (loan interest rate) is lower than the “return on investment” (the profit generated using the funds), then borrow, borrow, borrow!

For example, if you borrowed $100 for a week, and had to pay back $105 ($5 cost of funds), but using that money you could generate $110 (return on investment) in a week, wouldn’t you borrow millions again, and again, and again?

How does this Finance 101 issue relate to your EIDL?? When the EIDL program was created interest rates were at 40-year lows and inflation was below 2%.? Currently 30-year mortgage rates are at 7.30%, and core inflation is near 4%.? Which means, paying off your EIDL early is not in your best interest (pardon the pun).? Instead, pay off your debt with interest rates greater than your normal return on investment, working your way to debt at 4% or greater.

Working Capital

Ever wonder why 20% of businesses fail in the first year?? Lack of working capital.? Working capital is the difference between current assets and current liabilities.? In other words, the difference between one year’s expenses and one year’s cash (or cash equivalents).? Essentially, your ability to pay 12 months of bills.

Most new businesses have virtually no working capital.? Meaning that if sales don’t immediately reach the “glorious” levels projected in a business plan, and instead normally “ramp up”, business owners have no means to fund this negative cash flow, and they fail.

After nearly 40 years of working with small businesses, I noticed a trend after the EIDL program.? Many of our existing small business clients, now “flush” with working capital were able to navigate their companies through skyrocketing wage rates, 9% inflation, and fluctuating demand.? Many of these companies still have EIDL funds remaining after 4 years.? Which begs the question, should the SBA change it’s regulations related to new small business lending?? Applying for and receiving an EIDL was a “no brainer” and until we have more information about EIDL defaults, we won’t know how successful this program was in supporting small businesses.

Action Plan

If you still have EIDL funds, conserve them.? The economy is still experiencing upheaval.? Add 5% to your monthly EIDL payments to avoid a balloon payment down the road.? Pay off your highest interest rate debt before accelerating EIDL payments.? And for those of you who are debt adverse and don’t like having a 30-year loan hanging over your head, take out a life insurance policy (payable to the company) equal to the amount of your EIDL.

If this article helped you, please click that “thumbs up” button.? If you have a comment or question, let me know and we can start a conversation.? I want to hear from you.? If you are interested in working with a cloud-based Trusted Advisor contact ARI today or visit our website .