How Will Rising Interest Rates Affect Your Loan?
Will that affect my current business loan or line of credit?”
For those who have thought about that issue, the answer is definitely “yes”, and not only that, it will make loans harder to get in the future.
While the credit crunch of 2009 – 2011 has eased somewhat, the picture for small and mid-sized private business continues to be precarious. In 2012, Bank of America began cutting its lines of credit to small business, many of them that were using that money to remain solvent. The bank demanded that a number of its 3.5 million small business customers pay off their loans immediately and those that couldn’t were offered new repayment plans with significantly higher interest rates.
Banks and other business lenders base their rates on their cost to get the money they lend out. Most lenders actually borrow that money from other banks and they do so based on the Federal Funds Rate. And while the Federal Reserve has recently left this rate unchanged at near zero, it is anticipated that it will begin creeping up in the near future, forcing the Prime Rate to eventually increase.
All Companies That Lend or Borrow Are Subject To Interest Rate Risk.
A company faces interest rate risk when rates change, affecting the company’s bottom line. Each loan, or borrowing company has its own interest rate risk, but the overall risk to each company can be affected by a number of factors:
1. Length of Loan Term
One of the largest determinants of the interest rate risk a company is exposed to is its loan terms on its borrowings and on any loan it issues. A business may face this problem if they offer terms to their customers at a fixed rate or even a zero interest rate. As its short term borrowing rate increases, it may find its bottom line impacted if it has to refinance its bank debt without being able to pass this increased cost to its customers.
2. Credit Risk
A company’s credit risk is, in part, determined by its debt to equity ratio. As interest rates rise, equity falls because the company is paying out more interest. This increases the overall credit risk of the company, which in turn causes lenders to raise interest on new borrowing. The more debt exposure a company has, the higher its overall interest rate is.
Do You Have Any Variable Rate Loans?
If Yes, Them Expect This …
If you currently have a variable rate loan, either a variable rate term loan or a line of credit, you can expect your interest rate to go up this year and next. Even if you have a fixed rate loan, when it becomes due, or before, you can expect your bank to get you to try and renew your loan at the higher rates as those rates move up.
Getting a business loan will become increasingly harder in some aspects. Loans are underwritten based on the borrower’s ability to make the loan payments (both principal and interest). But, if the interest rate increases, it means that the overall payments will rise, making it harder for a business to qualify.
When rates rise, money is harder to get, not just for businesses, but for their customers as well. This means less money to spend with your business. It usually means that when interest rates rise, inflation drops, because as money is harder to get, and as less spending happens, prices have to drop to attract customers to the company’s offerings.
However, This Recession And This Market Does Not
Seem To Be Doing Things In The Usual Way.
It is expected that inflation will continue to trend up over the next few years. This means that not only will customers be spending less money for goods and services, but those goods and services will cost your business more as well.
If your loan is:
- asset based, make sure that the values of those assets are up to date.
- receivable based, make sure that you are collecting on those receivables within the term of your loan.
- inventory based, make certain that as prices decline that you take the appropriate inventory write downs or, if prices increase, that you can demonstrate the increased value of your inventory.
Above all; even if the bank has allowed forbearance for a small covenant violation, make certain that you are back within the covenant as soon as possible. As interest rates increase, lending institutions will be less likely to be as understanding.
On The Bright Side …
On the bright side, and if you qualify; lenders will be more willing to make business loans as they increase profits from those higher rates. This means that for some businesses loans will be easier to get and more competitive from the various lenders.
What Should You Do Now?
What can you do to be one of those businesses that are highly qualified to borrow? The first is to focus on your cash flow and profit and loss statements. Be able to clearly demonstrate that you can not only make payments on the loan you are asking for today, but that should interest rates rise, you can make the payments under those circumstances. And be able to demonstrate that the loan you are asking for is not being used to fund losses, but to help your business grow and become more profitable.
Begin to lock in as many fixed rates as you can today, before rates and prices increase. Look at longer term supply agreements, rent and even labor agreements while rates and inflation remain low.
Lastly, if you believe that your bank may not be inclined to renew your loan when it becomes due, don’t be too proud to ask for help. The more time you have to restructure your financial statements, the more likely you’ll be to find a lending institution that is willing to say “yes”.