When comparing dental practice loans three things matter the most: rate, fees, and process. I recommend buyers comparing two loans weight their decision process about 50% on rate, 30% on fees and 20% on process. If you missed those previous posts, you can read more about that at the link above.
But a few factors don’t matter.
Several other factors listed in loan proposals give the impression they are a big deal and need to be compared to choose the best loan. I’ll mention three that are commonly discussed, but that, in my opinion, aren’t important enough to be considered serious factors in your decision.
- Prepayment Penalty
- Life & Disability Requirements
- The “Relationship”
These three points come up a lot when I’m working with practice buyers, but rarely make the difference in the loan decision. Often they come up because the various bankers are searching for ways to differentiate their loan option from the others, and push the points below. I’d do the same thing if I were a banker! If the numbers are close (especially if another bank’s numbers are better), I’d look for qualitative aspects of the loan to point to so the buyer leans my way.
Why the Prepayment Penalty Probably Doesn’t Matter
Every dental acquisition loan I’ve seen has a prepayment penalty. The most common version is a 5-4-3-2-1, where the first year of the loan if you walk across the street to a competitor bank to refinance your entire practice loan, you’ll be hit with a penalty of 5% of the loan balance. If you do that in the second year of the loan, the penalty is 4%. And so on.
The other most common versions of the prepayment penalty I see are the 3-2-1, making the penalty 3% in the first year, 2% in the second year, etc. and occasionally I’ll see the X-X-3-2-1. The “X’s” show the loan can’t be paid off or refinanced in the first two years of the loan.
So if one bank has put a 5-year prepayment penalty on a loan and another bank has a 3-year penalty, wouldn’t bank #2 be a better choice?
Not really.
I’ll make my case with two points. First, “prepayment” doesn’t mean you can’t get ahead of your loan and pay it down a little ahead of time. Want to make an extra payment every 12 months? Green light. Have an extra $1,000 you want to throw at your practice loan? Go for it. The penalty doesn’t apply to these cases. The penalty is simply a protection against you closing down the loan with that bank and going across the street to a competitor.
Second, most dentists are extremely unlikely to pay off their practice loan in the first five years of ownership. Yes, I’m as debt-averse as you are. Yes, I agree having the flexibility to make oodles of money as an owner and pay off all your debts lightning fast would be awesome.
But after seeing the actual financial planning and tax work for dentists now for years and years, I have yet to see many practice owners pay down their practice loan in five years or less. The primary reason this doesn’t happen is that student loan debt tends to take precedence. Additionally, there are some pretty nice tax breaks on practice debt that owners are reluctant to lose once their accountant shows them how it all works. Finally, dentists are unlikely to need to take advantage of the prepayment penalty option when rates are fairly low. As I write this, the prevailing practice loan rate is around 7% with many borrowers getting rates in the high 5’s or 6’s. Those numbers will change, but once you factor in inflation and the previously-mentioned tax breaks on corporate debt, prepayment of your practice loan makes less and less sense.
Could you be the exception? Sure. Maybe you went the military route, have no student debt, plan to live on ramen and in an 800 square foot apartment as an owner and will be retired by age 40. Maybe you’re reading this article several years after I wrote it and interest rates are sky-high. But even in those cases, the most likely scenario for the majority of practice buyers is they don’t need to factor in the prepayment penalty as a major deciding factor.
Why the Life & Disability Insurance Requirements Probably Don’t Matter Either
It’s extremely common for a bank to loan you gigantic sums of money with no collateral beyond your dental school diploma to protect against disaster. “Disaster” for most dentists takes the form of physical disability and sometimes death. You not being able to practice dentistry in the business the bank bought for you would not be good — for you OR the bank.
On practice loans, most banks will require you to buy, pay for, and then “collaterally assign” life and disability policies to them. That means if you die or get disabled, the bank collects on the policy first and you (or your family) get paid second.
So, naturally, some banks will compete on this point. They’ll require you to have the policies, but they won’t require you to collaterally assign the policy to them. Or (and this is more rare, but it happens), they won’t require you to have a policy at all. And then they’ll say their loan is the superior option because of this.
Here’s why the insurance requirements probably don’t matter: You should have life and disability policies for your new practice loan regardless of what the bank requires!
I’ll be more blunt. If you’re smart enough to get through dental school, and then going to take the risk of owning a practice and THEN you think you’re going to save a few thousand bucks a year by skipping having life and disability insurance — then you are a fool.
A 10-year term life insurance policy is dirt cheap. A business loan protection rider on an overhead disability policy (what I recommend in most cases) isn’t much more expensive, either.
You should have them both. And if the worst happens, you better believe the bank is going to get paid whether or not you collaterally assign them to the bank or not.
So, in my opinion, these requirements don’t make much of a difference for a borrower trying to decide between two banks.
“The Relationship” the Bank Talks About Isn’t a Real Thing
I get a lot of calls from bankers who want me to refer business to them. Invariably, I ask them what sets them or their bank apart. By far, the most common answer I get is, “We try to win business by having the best relationship with our clients.”
Say what?
What relationship?
I’m still waiting to hear a banker answer that question with, “You know what, Brian? I get the rate and fees as low as I possibly can.” That would get me to pay attention! (I haven’t heard that answer yet.)
When I ask what “having a relationship means” I usually hear something along the lines of, “We really try to understand the buyer’s goals and make sure they get into the right practice,” or “We do more than just the practice loan. We have the expertise to be the one-stop financial shop for our borrowers.”
You want to understand the buyer’s goals? I can tell you their goals: get a great loan with a really low rate with no fees and a good process.
You want to be a one-stop financial shop and have their checking account, credit card, merchant services, and investment relationship? Then have the best product in those areas and the buyer will hit you up.
The fact of the matter is, because dentists are generally considered the safest small business loan on the planet, supply exceeds demand. There are more bankers willing to hand out practice loans than there are dentists who want them. Dentists are in the driver’s seat most times with their ability to shop and price compare. I have nothing against a great relationship with the banker, but if I were the dentist I wouldn’t let “the relationship” steer me toward a loan with terms slightly worse than another bank’s option.
