Interest rates have a major impact on small businesses. Currently, interest rates are very low by historical standards. What do low interest rates mean for small businesses and your plan to start one?
Low Interest Rates: The Good News for Starting a Small Business
Primarily, low interest rates are very good news for small business owners. Just how are low interest rates good for starting a small business? The lower the interest rate, the less expensive money is to borrow. The lower the interest rate on a business loan, the lower the monthly payment you’ll be required to pay on it. Even a difference of one percentage point on interest rates can make a meaningful difference in the monthly amount you have to pay back to the lender.
Monthly debt service can tie up the capital needed for things like expansion, so the lower your payments, the better for your business overall.
Aspiring business owners want to aim for the lowest debt service possible, since debt service ties up cash flow. Debt repayment on a $250,000 loan, for example, can be roughly $2,775. You will probably have much better uses for your cash flow! If business takes off, for example, you may want to produce more product or expand locations.
It’s also not uncommon for cash flow and profits in small businesses, especially in the first year or so, to be slim. It may even be challenging to achieve your projections. As a result, you don’t want to overload your small business with debt service that can prove challenging to repay – or impossible to repay.
It’s also good news to receive a business loan when interest rates are low because most business loans have fixed interest rates. That means you can lock in a relatively low debt service payment for the entire length of the loan.
Finally, low interest rates can be good news for your customer base. Lower interest rates sometimes make consumers more willing to buy or more able to take on debt themselves to purchase goods or services. A low-interest rate environment can help your business overall.
Low Interest Rates: Some Potential Drawbacks
There are some potential drawbacks to low interest rates and small business. Low interest rates can make getting a loan more competitive – and it’s already somewhat difficult to get a business loan. Only 15 to 20 percent of loans guaranteed by the U.S. Small Business Administration are approved, for example.
Most of the competitiveness stems from the factors lending institutions review when business owners apply for a loan. You need to have what financial institutions term “the 5 C’s: capital, collateral, creditworthiness, character, and capacity. But if a number of small businesses are trying to get low interest rate loans before rates go up again, the increased number of applications a financial institution has may also be a factor.
Learn More About Your Funding Options
Very low interest rates may also make the loan process longer – again, because of competition. A situation in which many businesses are vying for loans sometimes means that financial institutions can only get through the applications so fast.
Finally, periods of low interest rates may also lull business owners into believing that rates are always low. Interest rates have been at historically low levels since the Great Recession of 2008-2009, 13 years ago. But in fact, interest rates fluctuate with economic conditions.
Let’s look briefly at why interest rates fluctuate because it’s important for aspiring business owners to understand.
Understanding Interest Rate Fluctuations
The U.S. Federal Reserve controls the direction of interest rates by controlling the Federal funds rate, which is a benchmark for interest rates. Financial institutions move their interest rates in line with the Federal funds rate for business loans as well as other products such as mortgages, credit cards, and personal loans.
The Fed’s mission is to keep the economy relatively healthy, with as stable and strong employment as possible and minimal inflation. High inflation is a particular danger because it erodes the value of money and thus overall purchasing power. The Fed’s goal is to hold inflation at roughly 2 percent per year.
When the economy is struggling, as it did during the Great Recession, interest rates are decreased so that barriers to borrowing are lowered as much as possible. The Fed lowers interest rates, so business owners can continue to borrow to invest in their businesses and create jobs.
The interest rates triggered by the Great Recession primarily stayed in the same historically low band through 2020, with minimal fluctuation. The COVID-19 crisis also negatively impacted the economy, so they’ve stayed at historically low levels since it began in early 2020.
The economy may start picking up as vaccines, and other measures begin to control COVID’s effects on the economy, however. If the economy starts to overheat in the future, the Fed may raise interest rates to control inflation and other effects of a robust economy. The Federal Reserve’s Open Market Committee meets several times per year to review the economic situation and set interest rate policy.
If the Fed decides to raise the Fed funds rate, rates on business loans will rise higher. If you apply for and get a business loan when rates are higher than they are now, the monthly payments will be higher than they would be if you received a business loan now.
If you have one of the rare business loans with a variable interest rate, your payments will likely rise because banks will hike the rate if the Fed funds rate is increased. If you are using other forms of financing that depend on the direction of interest rates, such as a business credit card, the rates – and thus monthly debt payments – are also likely to rise.
The long and short of it? The effect of fluctuating interest rates is something business owners need to be aware of. Business owners need to think long and hard about their ability to repay any business loan in any type of interest rate environment.
ROBS: An Alternate Financing Solution That Doesn’t Rely on Interest Rates
If you’re thinking of starting a small business, financing may be a key need. Yet obtaining financing can be challenging. A low interest rate environment such as we have now is the best possible scenario for obtaining a small business loan. But again, these loans can be competitive. In addition, if you plan to get a loan at some point in the future, rates may be higher then.
If you’re new to business ownership, you may face particular challenges because lenders often like to see experience in business before approving a loan. The same is true if you’ve faced other challenges, such as a low credit score or insufficient cash or collateral to obtain approval.
So what’s the solution? Look for financing sources beyond business loans.
One of the most versatile financing methods, for example, is Rollovers for Business Start-Ups (ROBS). Twenty percent of small business owners surveyed in 2021 Small Business Trends used ROBS, making it the second most popular financing method after cash (which 39 percent of small business owners use). ROBS utilizes the retirement funds in vehicles such as 401(k)s and Individual Retirement Accounts, which many aspiring business owners already have.
ROBS financing can also be used in tandem with a small business loan, including the beneficial type guaranteed by the SBA, which can carry lower interest rates and longer terms. Small business owners can use ROBS for the down payment, which can be up to 30 percent of the purchase price.
Perhaps most advantageously, ROBS financing leaves a business owner debt-free. You will never have to make a monthly debt service payment, leaving all of your cash flow and profit free for other business purposes.
ROBS is structured so that you do not incur the tax penalties that normally follow a withdrawal of 401(k) or IRA funds.
Guidant is Here to Help Your Small Business Financing Needs
ROBS can be a valuable funding tool for aspiring business owners. But certain aspects can be complex. Guidant is happy to fully explain how ROBS works and how it can benefit you and your small business. We’re here to help you follow your small business dreams.
Contact us online or call us at 888-472-4455 to talk with one of our small business funding experts and learn more about financing options.