Understand your loans to save money

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As a youngster I had it drilled into me that you don’t buy things you cannot afford. . . . .but “affordability” also included the ability to buy things that you didn’t have the money for but you had a solid plan for repayment.  That thought process is known as using and building credit history.

You have also heard me say on this platform that if you watch the big public companies and what they are doing you can learn a lot and sometimes emulate their decisions in a way that will make your business more profitable.

Knowing how the interest rates are moving, where they are, and having a good credit history can be a valuable tool in your company’s toolkit to profitability when used.  I noticed on Monday an announcement by Service Corporation International (SCI) that they were willing to pay a premium to retire all of their 5.375% Senior Notes due in 2024.

You might ask why would they pay an extra amount to pay off this “loan” four years early.  Well, while I don’t know all of the exact details of this note the answer lies in the same thought process of refinancing your home when interest rates are low.  Think of it this way . . . SCI has said it has $850 million of debt with these notes that carry an interest rate of 5.375%.  Interest alone, on an annual basis on that amount will be $48.875 million.

Interest rates in America, generally, are set by the Federal Open Market Committee (FOMC) of the Federal Reserve Board.  The Federal Reserve Board is established by the United States government to set interest rates and monetary policy of the country.  Generally, the rate they set, known as the Federal Funds Rate is the interest rate banks charge to each other on overnight loans. . . . and many other rates are set off of that set rate.

It follows then that the lower the Federal Funds Rate is set, the lower other rates. . . such as for cars, boats, homes, and the like should be.  In

Tom Anderson
Funeral Director Daily

this case, SCI is betting, and is more than likely assured that the rates of investors buying their new notes to replace the ones retired, will be lower than 5.375%.

The Prime Rate which is a somewhat antiquated rate that is supposed to demonstrate the best rate that banks will give their best customers is at 3.25% today.  So, let’s say that SCI qualifies for the Prime Rate on their replacement notes.  Annual interest on $850 million at 3.25% would be $27.625 million. . . .if that is where SCI lands, then they will save over $21 million annually by re-financing these Senior Notes.

So, with that savings, SCI can offer a premium by paying $102 for every $100 of notes that a note holder owns and still come out on top.

What can a small funeral home owner learn from this short lesson?  My best teaching point of this article would tell you that whenever you come to some type of agreement for a business loan with a lender is that you should always insist on a “pre-payment” option.  Much like with these Senior Notes of SCI, circumstances have changed and they realize that with the interest rate drop, they can do better by re-financing.

The same can be true for your funeral home.

The shoe can also be on the other foot. . . as interest rates can rise.  The flip-side of the advice of the last paragraph is to always strive to get the longest term of a guaranteed interest rate that you can get, if you can afford that rate today, because it may rise and in those conditions it is nice to be able to have a stable payment that does not rise.

In short, a long-term rate guarantee with pre-payment options without penalty puts your business in a pretty good sweet spot to be able maneuver your boat through interest rate mine fields that may be in the future.

RelatedMoody’s says SCI refunding plan is a “Positive” development, but ratings unchanged.  Yahoo Finance.

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