The Federal Reserve’s recent decision to increase interest rates by 0.75 percentage points, for the third time this year, is a step taken to cool down the economy and lower inflation. However, this hike in rates may make some small business owners question whether to pursue opportunities for growth as the cost of borrowing continues to rise.
As the market currently predicts, the Fed could potentially increase interest rates even further by the end of the year. As a result, the rate on small business loans could reach nine percent or higher. In today's environment, most businesses are healthy and credit performance is strong because many were supported by the multiple government programs during the pandemic, including the Paycheck Protection Program (PPP) and Economic Injury Disaster Loan (EIDL) loans. However, the Fed’s aggressive actions to combat inflation will lead more business owners to second guess themselves in taking on new debt for expansion.
Here are two key items businesses must consider when looking to expand:
- Fixed or adjustable rate? Demand for fixed-rate loans is going up because businesses can lock in rates from one to three years, in comparison to adjustable rate SBA (Small Business Administration) loans which range from three to ten years. A fixed rate loan, even if it is a little higher than an SBA loan today, could pose a better option considering the market's prediction on interest rate increases. On the flip side of the coin, if the economy falls into a recession and the Fed starts cutting rates earlier than the current expectation, then the fixed-rate loan becomes more expensive and getting out of it, though an option, would entail prepayment penalties.
- Should I wait to access credit? Business owners who have been through economic downturns know that the time to access credit is before the economy and cash flows begin to decline. Experience has shown business owners that lenders are more hesitant to lend money when the economy is slowing down and interest rates are rising. These circumstances could entice business owners not to wait and see how rates may look during an economic downturn. However, as interest rates go up and inflation does not improve, the risk of violating debt service covenants increases.
Rates are not ordinarily considered the determining factor in a business owner's decision to pursue debt. The focus should be geared more towards the business opportunity. However, rates are a factor based on the monthly repayment amount. When comparing a business's cash flow against monthly expenses (such as payroll) that may become harder to make, and considering the competitive employment environment, business owners may be required to reconsider their expansion plans.
To learn more about this topic or to discuss your company's needs, please contact us.
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