28: Securing Financing

Chapter 28

Securing Financing

A banker is a person who is willing to make a loan if you present sufficient evidence to show that you don’t need it.

Herbert V. Prochnow


Objectives
At the completion of the chapter, students will be able to:
1. Define the common sources of loans for dentists.
2. Discuss these types of debt instruments with respect to the purposes, types, benefits, limitations, and uses for dental practitioners:
    Bank note
    Line of credit
    Promissory note
    Signature loan
    Installment loan
    Credit
    Mortgage
    Home equity loan
3. Define loan security and how it affects loans for dentists.
4. Describe the various types of interest rates.
5. Discuss the tax implications of debt for practitioners.
6. Describe how to control debt.


Key Terms
accounts payable
amortization
    installments
    amortization schedule
arm’s length transaction
balloon payment
bank note
banks
business plan
collateral
consumer debt
    charge account
    credit
    credit cards
    line of credit
    debit card
cosigner
credit unions
debt-to-income ratio
down payment
first lien position
home equity loan
    after-tax interest rate
    marginal tax rate
    nontaxable interest rate
    personal debt interest
    real after-tax rates
    tax deductible
    taxable interest rate
installment loans
interest
    APR
    compound
    fixed rate
    interest rates
    prime
    principal
    simple
    term of the loan
    variable rate
interest-only payments
lien
lien holder
lines of credit
loan committee
loan security
mortgage
owner financing
payment schedules
private banking
pro forma financial statement
promissory note
qualifying for a loan
second mortgage
secured loan
signature loan
Small Business Administration
unsecured loans
working capital


Goal
The purpose of this chapter is to understand the structure and use of various types of debt. Specific types of loans are discussed. Their use in personal and professional situations is detailed.

Debt can be a valuable financial tool, allowing a person to purchase goods or assets he or she could not otherwise afford (Table 28.1). It can also be a huge drain on resources, especially if not managed properly. Usually, debt is used for large purchases (such as home or practice purchase) when obtaining the item for cash would be difficult or impossible. The problem is, assuming debt means that a person must pay interest, adding to the cost of the asset, and he or she must pay off the principal, reducing the funds that are available for other purchase or investment purposes.

Table 28.1 Allowable Debt Levels

Type of debt Rule of Thumb
Consumer debt 20% or less of gross monthly income
Housing costs 28% or less of gross monthly income
Total debt 36% or less of gross monthly income

Bankers and loan officers have several rules that they go by when qualifying a client for a loan (and, therefore, debt). These rules are not simply made up by the bankers; they are often required by the agencies that underwrite the loan. For example, the Federal National Mortgage Association (Fannie Mae) requires that total monthly payment on all debt should be no more than 36 percent of the family’s gross monthly income. These debt payments include monthly housing costs, including taxes and interest, payments on installment credit, alimony, child support or maintenance payments, and any other payments on nonincome-producing property. Although some of these items (like taxes) are not really debt, they are a required periodic payment, and so lenders treat them as if they were debt.

Most professionals incur debt at some point in their career. Generally, this is during the initial phases, when practices, houses, and new automobiles are bought. Often professionals enter the marketplace with a large amount of preexisting debt needed to finance their education. This student debt may be so large that it impairs their ability to secure additional personal or professional loans. Most bank loan officers understand the large potential earning power of professionals and work to develop them as clients.


Box 28.1 Example Bank Loan
Dr. Jones buys a dental practice, securing an installment note for the amount shown. Her annual (estimated) payments are given. This shows only annual estimates. Loans are actually amortized monthly.

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As professionals move through their professional lifetime, the need for debt usually declines, as loans are paid off and assets are accumulated. So it is during the first several years that managing debt become crucial. Mistakes made early in a career can haunt a person financially for many years.

Sources of Loans

Banks are the best-known source of loans for the professional. However, there are many other potential sources of funds. Each has specific advantages and disadvantages.

Banks

Banks are the most common source of funds for new practice loans. Bankers are in the business of lending money to people that they think will repay it. So a dentist will need to convince the banker that he or she will repay the loan (Box 28.1).

There are two types of banks, national and local. National banks have an entire division dedicated to working with professionals. A dentist will work with a special internal group called “private banking.” The private banking section manages small business and other special banking concerns. Large banks may have people within their private banking group that manage only professional (or even only dental) practice loans. These people are knowledgeable about practice financing issues. The dentist may need to establish all professional (and often personal) bank accounts within the private banking section. However, it works well because the banker will know the dentist personally. Local banks, on the other hand, are variable as to their understanding of dental office finance. Some small banks do not have private banking sections. Instead, a dentist may need to educate the banker about the specific problems faced by dental practices. (Bankers do not like to take risks they do not understand.) The larger local banks have private banking sections and individuals who service professional clients. Many of these people are also knowledgeable and helpful.

Owner Financing

Many professional practices finance some portion of the cost through the previous owner. If the bank is unwilling to lend the entire amount, then the owner may finance the remainder of the purchase price. The seller does this by allowing the buyer to pay part of the price over time to the owner, rather than the lending institution. The seller will generally charge a comparable interest rate and require a promissory note, which details all of the terms of the loan. Owner financing carries additional risk for the owner over simply getting the entire ­purchase price as cash up front. If the buyer runs the practice into the ground, becomes disabled, dies, or is unable, for any reason to pay off the loan, the owner may not receive the entire purchase price. Generally, the bank will require a first lien position on all tangible (hard) assets of the practice, which means that it gets to sell the assets to satisfy its. So the owner may be left holding an empty bag. This may be the only way that the owner can sell the practice for the price that he or she wants. If so, then the buyer can expect to pay the owner a reasonable interest (comparable to a bank rate) for the portion that is financed. The buyer may need to finance the down payment through a bank and arrange the rest of the purchase price as owner financing to make the buyout work.

Dental Supply Companies

Most of the major national supply companies (e.g., Patterson, Sullivan-Schein, Benco) have arrangements with banks or finance companies that allow the dentist to borrow money to establish a professional practice. There is an obvious advantage for the supplier (the ­dentist buys equipment and supplies through them). The advantage for dentist is that he or she may qualify for financing through these organizations when he or she may not qualify at the local bank. The down side is that the dentist often pays a higher interest rate than he or she would at the local bank. The finance company may also have significant prepayment penalties and other disadvantageous loan clauses. The dentist generally must buy his or her equipment through the particular supply company as well. Some only finance new practices, not buy-outs of existing practices. Others only offer financing for equipment purchases or upgrades. However, these companies know the dental marketplace, and if a dentist is unable to gain financing through a bank, they may offer a method of financing the establishment of his or her practice.

Family Members

The dentist may be fortunate enough to have family members who have sufficient assets to lend him or her for practice or personal needs. If this is the />

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Jan 4, 2015 | Posted by in General Dentistry | Comments Off on 28: Securing Financing
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