4.04d Implement financial skills to obtain business credit and to control

its use

Identify risks associated with obtaining business credit

Variable (Floating) Interest Rate

Featureso Floating interest rates, also known as variable interest rates, are generally

tied to an index or other measurement of the market's current lending rate. o As the prevailing interest rate rises, so, too, does the interest rated attached

to the loan; as the market rate lowers, the loan's rate drops with it.

Considerationso When a loan is given a fixed rate of interest, the borrower generally pays a

consistent amount for each payment. o For example, for a 1-year loan of $120 at 10 percent interest, a borrower

making monthly payments would pay $13 each month. However, if the interest rate were not set at 10 percent, the amounts of his payments would differ.

Benefitso Fixed interest rates are beneficial to those looking for a steady payment

schedule, allowing them to anticipate future financial obligations. o Floating interest rates are beneficial for borrowers who anticipate that

interest rates will sink lower than the fixed interest rate loans currently available to them, saving them money.

Prepayment Penalties Fee paid to a lender for the privilege of paying off

a loan prior to maturity. A prepayment penalty, which may decline in the

years after a mortgage was originally booked, is intended to compensate the lender for loss of income in future years.

These are becoming less common as more mortgages are made at adjustable rates that rise or fall according to a Cost of Funds Index or a bank lending rate, such as the six-month Treasury bill rate,

Financial Covenants Financial covenants are part of the terms and conditions found in any

type of financial contract. The covenants represent specific commitments that all parties involved

in the contract are making to one another and outline what type of actions may be pursued in the event those covenants are not observed. o Typically, care is taken in drafting the financial covenants so that there is little to

no room for misunderstandings regarding what is meant by each covenant found within the body of the contract, and who is responsible for making sure that covenant is fulfilled.

The purpose of financial covenants in any type of working contract is to make sure that all parties understand the nature of the commitments they are taking on as part of their responsibility to one another. o By including the covenants within the body of a contract, and using verbiage that

is very direct and concise, the opportunity for any party to be unaware of his or her responsibilities is kept to a minimum.

o At the same time, the inclusion of financial covenants also protects the interests of all parties and goes a long way toward preventing losses as the result of entering into the agreement.

Financial Restrictions Financial restriction is a form of regulation or

supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the integrity of the financial system.

This may be handled by either a government or non-government organization. o The objectives of financial restrictions are usually: *

market confidence – to maintain confidence in the financial system * financial stability - contributing to the protection and enhancement of stability of the financial system * consumer protection - securing the appropriate degree of protect...

Subordination Agreements

A subordination agreement is a legal document used to make the claim of one party junior to (or inferior to) a claim in favor of another.

It is generally used to grant first lien status to a lienholder who would otherwise be secondary to another party, with the approval of the party that would otherwise have first lien. o Typically a subordination arises when there are two existing

mortgages, a first mortgage and a second mortgage, and the mortgagor intends to refinance the first mortgage.

o If the holder of the second mortgage does not subordinate the lien of its mortgage to the new mortgage, the new lender will not refinance the first mortgage.

o However, the second mortgage holder does not want to release its mortgage and re-file, due to additional costs and priority problems, so it will subordinate its lien to the lien of the replacement mortgage.

Identify Direct Financial Costs Associated With Obtaining

Business Credit.

Discuss Periodic Reporting Requirements Required By Lenders.

Explain Financial Covenants And Restrictions Included In Loan Agreements By Lenders.

Discuss The Use Of Subordination Agreements In Financial Covenants.

Explain The Use Of Personal Guarantees In Lending Policies.

Identify Factors That Can Be Negotiated To Replace The Use Of Personal Guarantees