How to Use Debt Responsibly In Your Practice When Interest Rates Are High

By Adam Cmejla, CFP®

The bank clerk is working with the calculator.

July 26, 2023

If there’s one thing true in practice ownership, it’s that the only constant thing is change. Even when the practice is firing on all cylinders and working well, there are still minor course corrections that need to be made to keep operations running smoothly.

From time to time, though, there are bigger changes that happen existentially that should cause ODs to think about how they make financial decisions in the practice, specifically how they use leverage (debt) when making capital investments into the practice.

There are only three ways that a practice owner can finance a major purchase in the practice.

The first option is to use a bank to provide the capital.

The second is to use their own personal capital and “bank on themselves” by making a capital (cash) contribution into the business. This can be viewed as either a capital contribution (which will increase the shareholder’s basis in the business) or as a shareholder loan (which must be documented on the balance sheet as a liability to the practice and for which payments along with interest must be paid back to the owner/shareholder at some point in the future).

The third is to use the practice’s own cash through retained earnings to invest back into the business.

Assuming the practice owner has liquid cash either in the business as retained earnings or in personal savings, which of the three options practice owners choose will be based on evaluating the two costs of capital.

  1. The direct cost of capital is going to be the interest rate expense associated with the debt incurred by going the route of bank financing.
  2. The opportunity cost is what the practice owner could have otherwise done with the cash and the subsequent return they could have earned on that cash should they have chosen to not invest it into the practice and instead use bank financing, thus incurring cost #1.

The interest rate market has changed significantly over the past 18 months in the post-COVID landscape. While practice owners were able to incur personal and business debt at record-low levels during and shortly after the pandemic, the Federal Reserve’s attempt at curbing the inflation challenge has led to several significant interest rate hikes (and potentially more on the horizon).

The ripple effects of these rate hikes find their way into all aspects of personal and business lending—from auto loans and home mortgages to business and personal lines of credit, home equity lines of credit, as well as business loans for expansions, startups or acquisitions.

One of the exercises to perform during this evaluation is calculating the interest rate arbitrage. This is essentially the process of determining what the cost of capital would be in the form of interest expense paid to the bank versus what a practice owner could earn on their money.

A Case Study
Let’s use an example to illustrate this more concretely. Say that a practice owner needs to build out another couple exam lanes because of  increased patient demand, and that, through the budgeting process, they determine it’s going to cost $150,000 all-in (build out expenses, equipment, etc.).

If our owner had $150,000 in retained earnings in their practice checking account, they now must evaluate the two costs mentioned above.

At the time of this writing (June 2023), the interest rate on a note like this over a 10-year term would be about 7.21 percent. Total capital cost is illustrated below:

Original loan amount: $150,000

Interest rate: 7.21%

Term: 10 years

Monthly payment: $1,757.91

Total Interest paid: $60,948.63

Total amount of payments: $210,948.63

We now have the information we need to determine the arbitrage rate to decide if it’s more advantageous to pay cash versus using the bank’s money (and incurring the above-referenced interest expense). Said differently, is there another investment that can provide us a rate of return above and beyond what we would pay in interest expense to make it “worth it?”

To evaluate this, we need to first look at the risk-free rate of return, which is commonly anchored to the 10-year Treasury Note. As of this writing, the yield on a 10-year note is somewhere between 3.448 and 3.985 percent (depending on the bond purchased). Clearly not a winner, as you’d pay more in interest expense on the note than you’d earn in risk-free interest income from Treasury Notes (not to mention the federal tax owed on that interest income, thus reducing the after-tax yield even lower and creating a wider negative arbitrage gap).

While there are shorter term Treasury Bills that can be purchased at a higher yield, it’s (a) still not as high as the interest rate on the loan and (b) our practice owner will have to worry about “reinvestment rate risk” when the Bill matures. This risk is defined as the risk that rates will be lower than they are today, thus creating a wider margin as illustrated above.

Knowing that we don’t have anything guaranteed that we can buy that will make it worth it, our practice owner is now faced with the decision of whether an investment that they select that isn’t guaranteed will outperform relative to the loan rate above.

The return of the S&P 500 index over the past 97 years has averaged right around 10 percent, but annual returns have only come within 2 percentage points of the average in just six of the past 97 years. When we talk to clients about investing, this is where I use the phrase, “To earn the average, we have to experience market cycles and the ups and downs.” Clearly, it’s no guarantee that the returns will consistently exceed the interest rate expense.

If we were having this same conversation 18 months ago, when interest rates for the same commercial loan were anywhere from 3.5 – 4.5 percent, the math looked a lot different because there were a variety of different investment vehicles to use that could create parity in the deal, thus allowing the practice owner to maintain liquidity and, best case scenario, find investment opportunities where there was a reasonable assumption that they would be net positive after paying interest expense on the loan.

Each investment carries its own set of risks and rewards that must be evaluated carefully and it’s a decision that will need to be considered on an individual basis. As we can see, the decision matrix changes as the market factors change.

Lastly, the importance of your own “peace of mind” cannot be overstated. I joke with practice owners that there is no “peace of mind” variable that we can insert into a financial equation.

There are some practice owners who, regardless of the exercise illustrated above, will always pay cash for their equipment, build-outs, etc. I can’t argue with that approach at all—that’s their choice, and one of the benefits of practice ownership is getting to make your own decisions and have that executive authority.

For those owners, there’s no amount of interest rate arbitrage that will overcome the peace of mind they have in not owing the bank money or paying interest expense on a purchase. For others, it’s a game of numbers and they’ll always be looking to maximize their return on investment, regardless of how it’s accomplished or what amount of risk they end up taking in the process.

All financial planning is simply the prioritization and organization of cash flow and understanding the implications of those decisions. While there are many internal and external factors influencing these decisions, the important thing for practice owners is to ensure that you have all of the facts—qualitative and quantitative—and that you’re making your decision well informed and educated.

Adam Cmejla, CFP® is a CERTIFIED FINANCIAL PLANNERTM Practitioner and Founder of Integrated Planning & Wealth Management, LLC, an independent financial planning & investment management firm focused on working with optometrists to help them reach their full potential and achieve clarity and confidence in all aspects of life. For a number of free resources, visit and check out the “20/20 Money Podcast” to get more tips on making educated and informed financial and business decisions.

To Top
Subscribe Today for Free...
And join more than 35,000 optometric colleagues who have made Review of Optometric Business their daily business advisor.