If your department is faced with these tough decisions, you might take a cue from the Federal Reserve. In reaction to slow economic growth, recent deterioration in the overall labor market and the growing unemployment rate, they recently decided they would not likely increase the federal funds rate through mid-2013. While today’s unprecedented low rates encourage more lending, this also translates into potentially low earnings on your department’s savings accounts.
When the economy shifts in this direction, consider reallocating your department’s savings toward paying debt. If you are considering additional equipment or apparatus, another strategy might be to put more money down on this purchase. Consider these options; your department may benefit:
Make a larger down payment or pay more toward debt, and gain greater savings on interest than you might earn from your deposits.
Put money down and borrow less on new purchases, and your department might be able to shorten the loan term while keeping payments the same.
Shorten the loan term, which in some instances reduces the overall loan rate, saving the department even more. This will also help you better manage your department’s debt schedule so it’s in line with the depreciation or value of the collateral.
The first loan scenario is for $100,000 at a term of 12 years, and a rate of 4.50 percent. The total interest paid on this loan is $31,629 with annual payments of $10,969. The total payment on the loan is $131,629.
The second loan scenario is for $80,000 at a term of nine years, and a rate of 4.25 percent. The total interest paid on this loan is $17,959 with annual payments of $10,884. The total payment on the loan is $97,959.
The information above gives you a comparison of borrowing 100 percent of the purchase price of equipment versus putting 20 percent down ... and the financial impact it can have for your department.
In each scenario, the loan payments remain virtually the same; however, in the second scenario, where a down payment of $20,000 was applied, the total payment savings was $33,670. After subtracting out the initial $20,000 down payment, the total net savings would be $13,670.
Compare this to the yield you would earn by investing the same $20,000 in CDs paying two percent over a nine year period. The earnings on the CD investment would be less than $4,000. By using the $20,000 toward a down payment instead, this would more than triple your rate of return based on the total savings of $13,670 for the department.
The end result: Your cash investment toward paying down loan balances will provide your department with a more well-managed debt schedule, a more flexible equipment and apparatus replacement schedule, shorter loan terms, better rates and more savings for your department!
Loren Pittman is a Commercial Loan Officer with LGFCU Financial Partners, LLC, a wholly-owned subsidiary of Local Government Federal Credit Union, working to improve North Carolina communities by partnering with, and making loans directly to, local government units across the state.