FORTUNE Small Business:

Pay back that loan ... later

Experts say that stretching cash to pay back loans can backfire.

Subscribe to Top Stories
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)

loan.ce.03.jpg
Ask FSB
Get small-business intelligence from the experts. Here's a chance for YOU to ask your pressing small-business questions, and FSB editors will help you get answers from the appropriate experts.
Your name:
* Your e-mail address:
* Your city:
* Your state:
* Your daytime phone #:
* Your questions:

(FORTUNE Small Business) -- Dear FSB: I own a small commercial building. The current loan rate is 7.11 percent, with a balloon set to explode on in November 2010. I'm currently putting all of my extra dollars toward paying off the debt. My goal is to pay it off before the 2010 balloon hits. If I max out my retirement savings to do it, however, that's it. Should I continue to try and pay off the loan ASAP, or spread my money to other areas such as mutual funds? Thanks for your help.

- Jon Sepeshy, Muskegon, Mich.

Dear Jon: Paying off that loan today might seem like a great idea, but it actually could backfire on you, according to Scott Snow of Scott Snow LLC. Snow spent 12 years as a financial advisor at Ernst & Young helping business owners manage their finances, and now has his own Westlake, Ohio, firm overseeing cients' investments.

"If you put all your money toward the loan you could find yourself in a bind if you face unexpected expenses - you lose tenants, the roof leaks, you need a new furnace," Snow says. "Then you'd have to go out and borrow at a much higher rate. Your rate of 7.11 percent sounds very good. In the future, you'd probably have to pay a much higher rate. When clients have excess cash lying around and pay down their loan I've seen it backfire. Consider some of the things that might happen with your building."

Terry J. Siman, president of Blue Bell, Pa.-based Vantage Point Advisors, agrees with that advice. Paying down a mortgage is rarely the best use of cash, Siman says: "You end up with less diversification and more concentrated equity, instead of spreading the risk around by investing that capital elsewhere. Even if you use the capital in 2010 to pay the mortgage down or off, it is smarter to keep it in a money market account until 2010."

Remember, adds Sean Monohan, a partner with Dallas-based Certified Financial Strategies, that the interest is tax deductible. Combined with building depreciation, that could give you a tax loss even if the building provides positive cash flows.

Depending on your situation, however, paying off the loan today could indeed be the best strategy.

"The answer lies in the reasons for owning the building," says J. David Lewis, president of Resource Advisory Services in Knoxville, Tenn. "If you want cash flow for a retirement to start near the time of eliminating the loan, then paying it off seems like an excellent idea."

When making your decision, consider how you feel about the debt, adds Lewis.

"We can almost always mathematically prove that keeping the loan while investing in [an S&P index fund] will produce the most dollars over five to ten year periods," he says. "However, this time period is only three years, with a risk of higher interest rates at the end. So, there is a great deal of uncertainty about 2010 and forward. I have seen clients understand the math and finance theory and still pay off the loan - for purely personal feelings about uncertainties associated with debt. I can never argue with that philosophy."

Lewis' conclusion: "If you just can't sleep at night with any debt, paying it off may be better than getting an ulcer between now and 2010." To top of page

Photo Galleries
Criminal's muscle car collection auctioned for $2.5 million These valuable classic muscle cars were seized as part of a money laundering plea deal. More
Ferrari 458 Speciale - Raw speed This bare-bones Italian supercar drops pretty much everything not needed for driving fast. More
America's most dangerous jobs America's workplace got safer last year. But these workers were still at a much higher risk of fatal injuries, according to the Bureau of Labor Statistics. More
Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.
Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.