Mortgage interest rates have been at or near record lows for the past several years, but experts are predicting that rates will see definite increases this year. As mortgage rates rise, other lending rates like those for small business loans often follow suit. A jump in interest rates can profoundly impact both current and potential small business borrowers.
1. Increased Cost of Debt
When interest rates rise, the cost of borrowing money increases for both lenders and borrowers. Banks and other lenders frequently borrow capital themselves from larger institutions like the Federal Reserve in order to have money to lend to small businesses. As rates go up, these banks have to pay more interest to their own creditors, raising their cost of doing business.
To compensate and offset this increased risk, lenders will raise the interest rates charged to small business borrowers on variable rate loans. Even a small 1-2% rise in rates can increase monthly loan payments by hundreds of dollars depending on the loan amount. Over the full term of a typical 5-10 year loan, that extra interest cost could tally $50,000 or more for the borrower.
Options to Mitigate Rising Rates for Existing Borrowers
Borrowers do have options to mitigate the impact of rising interest rates. Refinancing into a fixed rate loan locks in a rate that will remain constant for the life of the loan. However, refinancing usually requires significant upfront costs to process the new loan. Borrowers can also make every effort to pay loans on time and avoid late fees or penalties, while looking for ways to trim expenses or increase revenue to accommodate the higher monthly payments.
2. Tougher to Get New Financing
Higher interest rates don’t just impact current borrowers – they can also make it more difficult for businesses to qualify for new loans. Lenders closely scrutinize a borrower’s ability to successfully make loan payments in their underwriting process. When rates are high, the required monthly payment on a new loan will be higher, reducing the amount potential borrowers can qualify to borrow.
Steps to Improve Loan Qualification with Rising Rates
To improve their chances in a rising rate environment, borrowers should put together detailed financial documents like 3-5 year cash flow projections and profit-and-loss statements to convince lenders of their ability to repay at both current and elevated interest rates. Having substantial assets or collateral also helps offset risk for lenders. Borrowers should also be prepared to clearly explain how the loan will drive business growth and profitability.
Seeking Alternate Funding Sources
Seeking financing from alternative lenders like community banks, credit unions or online lenders may also offer lower rate options compared to big banks when rates are on the rise. With proper planning and diligence, financing remains accessible even in higher rate markets.
In summary, both lenders and borrowers need to factor in the impacts of rising interest rates. By modeling different rate scenarios and stress testing their finances, small business owners can smartly navigate an environment of increasing rates. Maintaining close contact with business lenders is also key to capitalizing on opportunities as rates rise.