Increasing interest rates good news, bad news for small businesses
Firms thrive in strong economy, but borrowing gets more costly
It’s a good news-bad news situation for small businesses when interest rates rise.
The Federal Reserve says the economy is doing well, so it has raised its key rates recently and is expected to do so again in the near future. The strong economy is great for most businesses, but higher rates will likely increase what it costs for them to borrow.
So what’s a small business owner to do? Understand how the system operates and consider the ways they can manage.
Here are a few basics to help:
The good news
Small businesses thrive when the economy is strong. Right now, the economy is doing quite well, which is why the Fed is comfortable raising rates.
The Federal Reserve, headed by Chairman Jerome Powell, doesn’t directly control the rates a business might pay on a credit card, line of credit or loan directly, but these rates tend to move in the same direction as the Fed’s benchmark rate. When the Fed raises its benchmark rate, it takes some time for that change to be reflected in the borrowing that businesses do.
Jared Hecht, co-founder and CEO of Fundera — a marketplace for small-business loans — said he has yet to see rates for small-business loans increase much, but he expects they will soon.
The bad news
Rising interest rates will likely increase costs for new small-business loans, existing variable-rate loans and credit cards. The exact rate a business will pay depends on the type of borrowing and their credit profile. It is typically prime rate, which is at 4.75, plus a few percentage points based on how favorable the lender finds the borrower to be.
But any way you slice it, a higher interest rate means higher costs that will eat into cash flow and profitability. Plus, short-term loans to cover cash gaps, often needed by small businesses, may get more expensive or difficult to acquire, said Barry Coleman, who helped develop the small business counseling program at the National Foundation for Credit Counseling.
What to do
Businesses have a few options in an environment of rising interest rates, experts say.
The simplest is to clean up your personal and business credit. Credit scores are a key factor when lenders decide whether to fund a small business. Make payments on time, use credit only when absolutely necessary and keep your utilization low. The better the credit score, the better the rates.
Next, think big picture about your strategic plans. If there are expansions or major investments you need to make, consider the timing in relation to rates and the economy.
Jerome Powell, chairman of the Federal Reserve, discusses interest rates at the Economic Club of Chicago on April 6.