Medial Office Equipment Interest Rate Costs

Dr. David E. Marcinko; MBA, MEd, CMP™

[Publisher in Chief]

Physicians, administrators and healthcare entrepreneurs are aware of the compounding effect of interest. However, since interest is deductible as a medical office business expense, many seem to forget about it despite the fact that it must be continually paid until the asset is either purchased or otherwise disposed. 

So, what are the various types of interest rates important to the medical practitioner and commodity – money?

[1] Simple Interest

Simple interest is merely the pro rata interest on a loan or deposit and represents the most basic interest rate type.

For example, for every $100 Dr. Bill borrows at 12 percent annual interest, he pays twelve dollars per year. The interest is calculated by multiplying the principal or original amount, by the interest rate in decimal form (100 x .12). 

[2] Add-On Interest

Add on interest immediately attaches the annual interest amount, to the principal amount, at the beginning of the payment period. Payments are then made according to the number of years required.

The following formula is useful: 

Add-on-Interest minus Payment  = Total Interest on Balance/Number of Payments

For example, if Dr. William Needy borrows $10,000 at 8 percent add-on interest, he will repay $10,000 plus $ 800 ($10,000 x 8%) or $10,800, divided by twelve months, for a total of $900 per month, since $ 900/month x 12 months equals $10,800.  

[3] Discounted Interest

When using the discounted interest method, the interest amount is deducted from the principal right up front. Notice that this is the opposite of add-on-interest that is applied up front.

For example, if Dr. Bill borrows the same $ 10,000 at a discounted interest rate of 8 percent, he will only receive a $9,200 loan, since $10,000 – $800 is $9,200.

Obviously, the discount method is the most expense way to borrow money.  

[4] Annual Percentage Rate

 Most financial institutions advertise an annual percentage rates (APR) for loans, deposits and investments.  The APR is the periodic interest rate multiplied by the number of periods a year. If the APR is 12 percent, and interest is compounded monthly, you receive (or pay) 1 percent of your balance each month, and the balance shifts with each compounding. 

For example, if Dr. Bill deposits $ 100 dollars at 12 percent APR compounded monthly, he receives $ 1 interest the first month (1% of $100), $1.10 the second month (1% of $101), and so forth. If compounding is daily, the interest accumulates at the rate of 1/365 of the APR each day.  

Unless interest is compounded annually, the APR will be lower than the effective annual interest rate, discussed below. 

[5] Effective Interest Rate

It is important to differentiate between the effective interest rate and the APR, which is often the most prominent figure in advertisements for medical business equipment, consumer goods and financial services (loans, annuities, IRAs, CDs, investment analysis, college funding or retirement planning).  Although the APR is the periodic interest rate multiplied by the number of periods per year, the effective annual interest rate is the periodic rate, compounded. 

In our case, if the APR is 12 percent, compounded monthly, the monthly interest rate is 1 percent and the effective annual rate is the monthly rate compounded for 12 periods.

Therefore, if your calculation is for a single year, you can treat the effective rate as simple interest. If you deposit (or borrow) $1,000 at 12 percent APR, the effective rate is 12.68 percent, and interest for the first year is about $126.80 (12.68% of $1,000).

For longer periods, you can use the effective interest rate as the periodic interest rate, compounded annually. 

[a] “Rule of 72” (Double your Money)

The number of periods required to double a lump sum of money can be quickly estimated by using what is known as the “Rule of 72”. To get the number of periods, usually years, just divide 72 by the periodic interest rate, expressed as a whole number (not a decimal).

For example, if the annual interest rate is 10 percent, it will take about 7.2 years (72/10) to double any lump cache of money. Conversely, you can also calculate the interest rate required to double your money in a given period by dividing 72 by the term.

Thus, to double your money in ten years, you need to earn about 7.2 percent annual interest (72/10) = 7.2%).  

[b] “Rule of 78”

According to this method, interest is front end loaded like a home mortgage, or office condominium, to discourage prepayment of a loan and consequently preserve the lender’s profit. In other words, it is a method of calculating installment loan interest rebates. 

The number 78 comes from an approved method of accelerated tax depreciation, known as the “Sum of the Years Digits” (SOYD) method (i.e., 12 + 11 + 10 + 9 . . . = 78). This fact is important because, throughout the period of a loan, even though the payments are all the same, the portions that are interest and principal are very different.

Using this method for a one year loan shows that, in the first payment, 15.38 percent of the interest due is paid off, and by the sixth month, 73.08 percent of the interest is paid off.  This means, that if a physician makes a one year equipment loan with a total interest charge of $ 100 and pays the loan off in full with the sixth payments, he or she will not get an interest rebate of $ 50, but only $ 26.92, since $ 73.08 of the interest has already been prepaid. 

Most ethical lenders use simple interest rates for loan rebates, and the Rule of 78 is unfair according to many authorities.  

[c] “Rule of 116”

A derivative of the Rule of 72 is the Rule of 116.  This determines the number of years it takes for a principal amount to be tripled and is calculated by dividing the annual interest rate into 116.

The Rules of 72 and 78 are very handy for figuring the amount of interest payments made or growth of funds invested. They can also be used in reverse to calculate at what rate of interest money must be invested to double or triple in a certain number of years.     

[6] Medical Equipment Payback Cost Analysis

The payback period, expressed in years, is the length of time that it takes for the medical equipment investment to recoup its initial cost out of the cash receipts it generates. The basic premise is that the quicker the cost of an investment can be recovered, the better the investment is. It is most often used when considering equipment whose useful life is short and unpredictable.

When the same cash flow occurs every year, the formula is as follows: 

Investment Required / Net Annual Cash Inflow = Payback Period 

Thus, in today’s tightening medical reimbursement atmosphere, practice cost control and expense reduction is the easiest method to increase medical office profitability.  Keeping the cost of the commodity money in the form of interest rate charges, as low as possible, will assist in this endeavor 

Assessment

And so, how have these rules affected your medical office borrowing costs; if at all? Does these principles apply to the medical student loan crisis, today? 

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