How to Handle Another Painful Rate Hike
More bad news for small business owners – for the fifth time since March, the Federal Reserve Board has hiked the overnight rate, this time by 75 basis points (0.75%) as part of a year-long effort to tame inflation.
The latest hike will further drive up the cost of capital on most loan products, especially those being offered by traditional banks, and cause more pain for small business owners that have had to rely on financing this year in the wake of skyrocketing inflation, supply chain disruptions and rising worker salaries.
How Painful is the Hike?
Small businesses that rely on financing have already bore the brunt of several rate hikes this year, and the latest rate hike will further raise the cost of capital for both fixed- and variable-rate loan products. The first pain point will be felt by small businesses that already have variable rate financing tools in place, since a hike to the overnight rate means that the prime rate – the interest rate commercial banks charge their most credit-worthy borrowers – will once again rise.
The prime rate, which is used as a base rate for variable rate financing products such as business lines of credit, which often charge the prime rate plus several percentage points as the cost of capital, will rise once again. Since March, the prime rate has risen from 2.75% to 5.5%, and after this hike, could rise to 6.25%.
What are the Current Loan Interest Rates as of September 2022?
It’s impossible to tell how high interest rates will go on specific lending products, since the rates charged greatly depend on the creditworthiness and other factors of the borrower. It is fair to assume, however, that the cost of capital for fixed-rate lending products, such as term loans – especially those being offered by traditional banks – will continue to rise. One measure to examine are the rates on the most popular small business loans out there, the SBA 7(a) loan.
The 7(a) loan is a term loan offered through partner banks to small businesses with generally excellent credit history and at least two years in business. At the end of 2021, when the prime rate was just 3.25%, the maximum interest rate on a 7(a) loan of $25,000 or less with 7-year term or less was 7.5% (assuming the borrower has excellent credit).
As of the end of August 2022, with the prime rate being 5.5%, the same loan carries a 9.75% rate. For a loan of $50,000 or more with the same term, the rate was 5.5% at the end of 2021, and in August 2022, it was 7.75%.
What can Small Businesses do?
No matter how you slice it, small businesses are going to have to pay higher rates now than they would have at the beginning of the year for most types of financing. If you already have a variable-rate loan, such as a business line of credit, the first thing you want to avoid right now is drawing down that line of credit since you will have to pay a higher interest on any money borrowed.
Try to Renegotiate
One action to consider is attempting to renegotiate the terms of your loan with the lender, especially if
rising rates will affect your ability to pay back borrowed money.
Remember, if you declare bankruptcy, it will be a long and costly process for the lender to recover any borrowed assets from you, so that’s an option they generally want to avoid and therefore, they will most likely be willing to work with you on a realistic plan to modify your loan. One thing that you can use as a negotiating tactic: if your credit score has improved since you opened the line of credit, you can use that to try and notch a lower interest rate.
If your small business needs financing during this period of rising rates, try to select the lending product that generally offers the lowest interest rate: an SBA loan. While interest rates have risen for SBA loans, they still generally offer the best interest rates and most flexible terms. The downside is that in order to obtain an SBA loan, you usually must have an excellent FICO score as well as a strong cash flow and several years in business, among other qualifications.
If you are seeking a business line of credit, you may even offer to put up collateral even if you have an excellent credit history, as secured lines of credit typically offer lower interest rates since the lender is taking on less risk. Additionally, term loans are typically cheaper than other types of financing, such as merchant cash advances and equipment financing.
Consider Alternative Lenders
An alternative lender, such as Kapitus, may be a good solution for you if you are seeking financing. Alternative lenders typically offer faster approval with fewer requirements and paperwork, and many have upgraded their customer service over the years to offer personalized service.
Additionally, higher interest rates mean that traditional banks will be tightening their lending standards and make it more difficult for small businesses to obtain a loan, so alternative lenders may be a more appealing option if you’re seeking financing since they typically have less stringent requirements for potential borrowers.
While now is not a great time to seek financing, just remember: interest rates rise and fall over time, depending on economic conditions. The Fed is hiking the overnight rate to combat inflation, so the high interest rate environment won’t last forever. If you must seek financing, try to go with the products that offer the lowest costs of capital possible, and consider looking at lending marketplaces to make lenders compete for your business.