Whenever you take out a loan, it is very important that you consider that the structure you decide best suits your individual situation and financial goals. There are many options to consider – interest only vs principal and interest, loan terms, fixed vs variable, security offered etc – it can be quite a minefield!
Whilst your accountant should play a part in discussing structure, as there are potential tax implications whichever way you go, here are a couple of thoughts to get you thinking:
Interest Only or Principal and Interest?
This is a topical question for any investment, including a pharmacy purchase or refinance. The answer depends a lot on the business itself and also your own personal situation. One of the prime reasons that a borrower elects to have interest only, is that it reduces the amount of funds required to service the loan, in that the principal component is not required. This option is generally taken when the borrower has a better use for those funds, rather than paying off the principal. Some reasons could be that those funds are diverted to paying off other debt – such as a non-deductible housing loan, or in the early years of a business, the owner may prefer to retain those funds to support cash flow.
Ultimately though, as a pharmacy owner, you will need to convert to principal and interest at some point, as lease lengths need to be considered, as most banks will want to see loan terms linked to the remaining time on a lease. This can have an impact if the remaining lease term is relatively short, and in some cases interest only is not achievable.
It is best to discuss your options and situation with both your banker and accountant.
Fixed Interest vs Variable?
Generally a borrower looks to take a fixed product for two reasons – they believe rates are on the rise and a midterm fixed rate offers protection against same or they want to lock in a known payment amount to give certainty to cash flow.
These are two benefits that a fixed rate can offer, but there are some considerations which may mean that a fixed rate may not suit. Most banks have restrictions on the additional amounts you can pay on a fixed rate, so if you have additional funds or are in a position to pay your loan off quicker, a variable product may suit better. Additionally, if you feel that you might be considering sale of your pharmacy, if you are on a fixed rate, you may incur break costs if you break the term early, so some planning is advised on your midterm goals as breaking can be costly.
A number of borrowers like to hedge their bets and place some of their lending on a variable product, and the remaining portion on fixed, which gives the borrower the flexibility of variable and the surety of a fixed rate.
What security should I consider for my loan?
A lot of borrowers look to secure solely against their pharmacy(ies). This approach limits risk to any cash or real estate assets that a borrower may have, but may also mean there are some limitations on structure for borrowers.
A popular structure and strategy, particularly for single pharmacy operators is to link their housing asset to the pharmacy lend. One of the benefits of this approach is that most banks will be more prepared to offer extended interest only periods on the business loan, and structure the home loan such that it pays down much quicker. There are potential tax benefits with this approach as the non-deductible debt is paid down much quicker, whilst maximising the deductibility of the business debt. There are also pricing benefits in this approach, as it is likely the lvr on the loan will be lower and as there is less risk with real estate security, most banks will be prepared to offer better rates on the business loan.
This type of strategy is an overall solution that your banker should discuss with you, but equally should also be discussed with your accountant.
For more information on Pharmacy lending, please call Tanya Mehinagic on 0459 808 331 ortanya.mehinagic@suncorp.com.au
by Chris Britton – Executive Manager Business Banking Suncorp Bank Health