How Business Loans are Impacted by Changing Interest Rates

After years at record low levels, there’s only one way interest rates can go from here, and that’s up. The question is when, as economies worldwide are still trying to recover from the disastrous impact of the COVID-19 pandemic. As a business owner, changing interest rates can affect you in many ways, from how much customers spend to your own borrowing affordability if business loan rates go up.

When people talk about interest rates, they are talking about what banks charge to borrow from them. The benchmark for borrowing costs is set by the central bank. In the U.S., this is the Federal Reserve, which decides the rate at which banks should lend to each other (this is called the federal funds rate). This affects your small-business loan interest rate, as personal and business loan rates are based on the rate the central bank sets. However, other factors such as personal and business credit history, your collateral, and length of time trading will also determine the business loan interest rate borrowers get.

Interest rates affect all businesses because they affect how the economy functions. For example, when the economy is slowing and consumer spending is weak, a central bank can lower interest rates to stimulate economic growth. It also works in reverse: A buoyant economy can withstand higher interest rates. When companies have fixed-rate rather than variable-rate business loans, they may not feel the effects of interest rate rises straight away, but this could change when the time comes to seek out new sources of funding.

The Impact of Business Loan Interest Rates on Small Businesses

Small businesses in particular can see the effects of changing interest rates amplified because they tend to run with lower cash reserves and are generally more vulnerable economic shocks. Here are a few ways changing interest rates can affect small firms:

Impact on Business Planning

When interest rates are changing, you may struggle to know what the cost of future borrowing will be (or the cost of existing business loan rates if you have a variable-rate loan) will be, and this can make it hard to plan your company’s finances.

Impact on Cash Flow

When interest rates rise, you may have to use cash reserves to service the rising cost of debt or, as business loan interest rates rise, you may be unable to access cheap credit to plug short-term cash flow gaps. This can mean you struggle to maintain healthy cash flow in your business.

Impact on Your Access to Credit

Higher business loan rates make long-term debt more expensive and short-term debt harder to obtain. Rising small-business loan interest rates can mean it is harder to access affordable capital to sustain and grow your company, hampering your long-term business goals.

Impact on Your Customers

When interest rates rise, consumers tend to save more and spend less, which means your sales could fall and your profits may become squeezed. However, rising interest rates are a sign that the economy has grown stronger, which means the long-term picture is broadly a positive one for the business owner.

How Do Higher Interest Rates Impact Businesses?

Central banks know there is always a ripple effect for companies—and the consumers that buy their products and services—whenever interest rates move. Higher rates mean a higher cost of capital for businesses, plus greater household debt costs and less discretionary spending power for consumers. For this reason, whether interest rates go up or down, usually policymakers only move them gradually to try to avoid any shocks to business, which could in turn destabilize the economy.

From a business owner's perspective, this might not provide enough reassurance. It's a good idea to review your business loans and other borrowing regularly to make sure you would not struggle to make repayments if your business loan rates suddenly increased. Before getting a business loan at a variable rate, use a business loan rates calculator to stress-test your affordability at higher interest rates.

The Types of Business Loans And Which Is Best For You

If you are thinking of getting a small-business loan, there are many options to consider. Depending on how you intend to use the money, there will likely be a suitable type of business loan out there for your purpose. Here are a few of the most common types of business loans:

Startup Business Loans

Startup business loans help entrepreneurs get new enterprises off the ground with all-important early-stage funding. You could consider equity financing, debt financing or alternative financing such as crowdfunding. Some entrepreneurs will use personal loans for this purpose, although it is a high-risk strategy to link the success of your business to your own personal finances.

Bad Credit Business Loans

There are specialist lenders who will grant business loans to those with adverse credit, although the increased risk to the lender usually comes at a cost to you. Business loan interest rates are likely to be higher in this scenario, so be sure that you really need to borrow now. Waiting and rebuilding your credit first by repaying a credit card balance or small loan should open the door to cheaper borrowing in future. Many lenders will have their own online business loan calculator so you could see how much a bad credit business loan might cost if your application is successful.

Equipment Financing

You can get specific business loans to buy or lease physical equipment, hardware or machinery. Your loan will be secured against the assets you are borrowing to buy which can reduce the business loan interest rate.

Commercial Real Estate Loans

Commercial mortgages or bridge loans can help you buy new premises or renovate existing commercial space you own, for example.

Working Capital Loans

Working capital loans are typically short-term business loans to help you maintain a healthy amount of working capital in your business, especially useful for seasonal businesses.

Line of Credit

A more flexible type of finance where you have access to a pool of capital to use as and when you need it, without the rigid repayment schedule of a typical business loan. This could be a revolving line of credit where you can borrow again up to your agreed limit once you have repaid some of your business loan, without having to reapply for a new loan.

Term Loan

A standard type of business loan with a fixed (usually monthly or quarterly) repayment schedule and a fixed interest rate, useful for acquisitions or company expansion. Once you’ve repaid the business loan, you would need to make a fresh application for any new borrowing. Again, a business loan calculator can help you get an idea of how much you could borrow, and the total cost.

Invoice Financing

Get a capital advance by borrowing against the value of your outstanding invoices, helping to solve cash-flow issues caused by late-paying clients.

SBA Loans

Small-business loans and microloans partially guaranteed by the U.S. Small Business Administration (SBA) could be an affordable long-term option for small companies. Those with good credit records especially could benefit from competitive small-business loan interest rates.

To find the best business loan for you, think carefully about what your business loan will help you achieve—whether it’s buying new inventory, equipment or just to use as everyday working capital. Use a business loan calculator to compare business loan interest rates, see how much borrowing will really cost you in total and play around with the term of the loan to find your optimum repayment schedule.

Other Factors That Can Influence Your Business Loan

Affordability

If you're likely to need new borrowing in the next few years, affordability could be an issue if rates are higher. In that case, it might be better to either borrow now to lock in a lower rate, or try to make cost savings elsewhere so you can build up a buffer of excess cash to fund future expansion, and hopefully earn a little more interest on it in the meantime. Alternatively, you might decide to put the brakes on investment spending in an environment of higher business loan rates.

Shopping Around

Refinancing your existing borrowing during a time of low business loan interest rates is worth considering, but think carefully about consolidation, especially if you're doing it to facilitate more borrowing in an environment where interest rates could rise.

Business owners are busy people and may not have time to shop around for the best deal. If that’s you, consider using a broker to help you in getting a business loan; you could recoup their fee quickly in the interest you save. Use a business loan calculator for a quick illustration of how much a lower business loan interest rate could save you over the full term of a business loan.

So, whether you’re looking at startup business loans, bad credit business loans or getting a small-business loan as an established firm, you should keep a watchful eye on interest rates to make sure your business loan or other borrowing is always fit for purpose.

A version of this article was originally published on December 5, 2019.

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