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The US economy is doing well—but you likely already know that as a small business owner. Optimism among small business owners is historically high, and so are interest rates. The Federal Reserve hiked rates in December of last year, again last month, and signaled that further interest rate increases are on the horizon for the remainder of 2018 and the years ahead.
As the economy grows, the Fed has steadily increased interest rates to keep a handle on inflation and encourage investment, too. But rising interest rates usually ripple throughout the economy and impact the cost of business loans. You know the drill—small business owners who have a business loan, or want to apply for a loan, are concerned about access to capital and whether higher rates will eat into their cash flow.
When interest rates are high and climbing higher, it’s completely reasonable for you as a small business owner to worry that money is getting more expensive. Do you need to be concerned about looking for small business financing or carrying a balance on a business credit card if money’s getting more expensive to borrow?
Here’s how rising interest rates might affect your business loan and business credit card, plus what to expect in the months and years to come. You might be surprised to learn that rising market rates could actually be a good thing for your business.
The Federal Reserve Bank affects anyone in the US who owns a business or a house, has a bank account, or went to school on student loans. So, you know, quite a lot of Americans—and likely you, too. As the country’s central bank, the Fed sets nationwide monetary policy.
Last month, the Federal Reserve Bank increased the federal funds rate to 1.75%, the second increase in the last four months. The Fed also signaled that two more rate increases are coming this year, along with additional increases in 2019 and 2020.
The federal funds rate is the interest rate at which banks lend to other banks, and serves as a benchmark for other interest rates. When the Fed increases the federal funds rate, banks usually follow suit by increasing interest rates on their credit cards, deposit accounts, business loans, and other products. The prime rate, which is the average rate that commercial banks charge their most creditworthy customers, also changes in tandem with the federal funds rate.
The federal funds rate has been on an upswing since 2016, but the Fed has been more aggressively increasing the rate during the last few months.
Graph Courtesy of Macrotrends
The rise in rates reflects the Fed’s optimism that the economy is growing. When the economy grows, people spend more, start new businesses, and expand existing businesses. The result is that there’s greater demand for credit, and the price for greater demand is a higher interest rate.
Increases in the federal funds rate usually spill over into other sectors of the economy. Mortgage rates, credit card APRs, and student loan rates all tend to increase. And business loans are no exception, of course.
Bill Dunkelberg, Chief Economist at the National Federation of Independent Businesses (NFIB), says, “The economy is doing well, and as the federal funds rate goes up, interest rates on variable-rate loans, business loans included, will go up as well.” Higher rates won’t impact borrowers who currently have fixed-rate loans, but they will affect new applicants and borrowers with variable-rate loans.
If you have a variable-rate SBA loan, for example, you can expect your rate to increase in lock step with rising interest rates. The Small Business Administration (SBA) sets maximum interest rates on SBA loans, tied to the prime rate. For instance, banks can charge a maximum markup of 2.75% over the prime rate for a 10-year $100,000 SBA 7(a) loan. Two years ago, an SBA loan of that size had an interest rate of 6.25%, but it’s 7.50% today. The difference works out to more than $8,000 of interest over the life of the loan. That’s money that the business owner could have reinvested back into the company.
Any business owner with a business credit card is also likely to see a rate hike—something important to watch for if you tend to carry balances. That means the money you don’t pay off will get more expensive.
Credit card issuers link business credit card APRs to the prime rate. For example, your APR might be “prime plus 12%.” That would have been a 15.5% APR two years ago and a 16.75% APR today. This difference will mean nothing to you if you pay your balance in full every month, but, again, those rising rates will increase your monthly payments if you only pay the monthly minimum on your card.
Obviously, rising interest rates are important to you if you have a variable-rate business loan or a business credit card that you don’t pay off every month. But even if that’s the case, you’re not helpless!
NFIB’s Dunkelberg says that small business owners can negotiate with their bank or call their credit card issuer if they receive notice that their rate will go up. Ask the lender to keep the rate the same or agree to a smaller increase. “Lenders are generally receptive to borrowers with good credit and who have made all their loan payments on time,” Dunkelberg says.
Small business owners can also try to refinance a variable-rate business loan with a fixed-rate product. With this approach, you can lock in a good rate. Just beware of prepayment penalties and refinancing fees.
Greg Hockenbrocht, who works closely with lenders on the Fundera platform, reiterates that lenders care more about their relationship with customers than increasing rates. “The reality is that banks often make economic decisions that are unique to their market position, and increase and decrease rates on loans and deposits to the degree that they can continue to increase profitability and competitively offer products to their customers.”
In other words, lenders might increase interest rates as a result of the larger economic environment, but they’ll consider a number of factors before making the decision. Your credit score, your business’s revenues, your repayment history, and the bank’s relationship with you as a customer all matter as much or more than the prevailing market rate.
This might be unexpected, we know—but rising interest rates could also have some positive side effects for small business owners. One is easier access to capital.
Normally, brick and mortar banks shy away from small loans (less than $250,000) because it’s simply not profitable for them to spend lots of staff hours on underwriting and processing small loans.
However, as the economy grows, and banks are able to charge higher interest rates, they profit more from loans that they issue. This makes banks more likely to consider smaller loan requests from small business owners.
In addition, small business owners shouldn’t lose sight of the bigger picture. Although interest rates are rising, that’s because the economy is doing well. Small business owners are reporting higher profits and job growth. Recent tax reforms will also help small business owners keep more of their revenues.
All of this means that small business borrowers can expect a greater return from capital, even if interest is higher. Dunkelberg says, “The outlook for the economy is very positive, so if a small business owner invests in a building, equipment, or other assets, the expected return is higher.”
The current economic environment means higher interest rates, especially for variable-rate business loans and credit cards.
Surprisingly—and luckily—small business owners can negotiate the rate that they’re paying on interest with their lender before seeing a huge increase. Small business owners should also take advantage of positive economic prospects. Higher interest rates could also mean more revenue, more job growth, and a better outlook for your business in the end.