Access to low-cost capital is more important than ever for America’s small business owners. If you’ve been researching ways to fund your business, it’s likely that you already have a checklist of important factors to consider. It’s also important to consider finding a lender who is completely transparent, who can help determine details like what the fees will be, amount of money you can borrow, and how long the loan term is going to be.
Finally, determine if the annual percentage rate (APR) is fixed or variable. Here’s some information about both Fixed Rate Loans and Variable Rate Loans to help you make an informed decision.
When seeking a loan, you might come across terms you are unfamiliar with. Here are a few common terms you might see in a loan agreement:
For additional terms important to small business owners, visit the SmartBiz Small Business Blog: Glossary of Terms for Small Business Owners.
Variable rate loans are loans with an interest rate that will fluctuate over time in line with established interest rates. They generally have lower starting interest rates than fixed rate loans, but the interest rate and payment amounts can raise or lower over time. SmartBiz offers a variable rate on SBA 7(a) loans.
Examples of variable rate loans include:
Typically, variable interest rates fluctuate based on some sort of benchmark figure. In the U.S., the most common such benchmark is the prime rate. This rate is innately connected to the Federal Reserve funds rate, which the government controls. Lenders can profit when they charge borrowers a margin or spread atop the prime rate.
Here are the current rates for an SBA loan through banks in the SmartBiz network:
Interest Rates
6.75% - 7.75%
Why does the Prime Rate fluctuate?
The Prime Rate generally changes sporadically. It may stay the same for years, but it may change several times within a single year. The Prime Rate is determined by meetings of the Federal Open Market Committee of the Federal Reserve Board.
The Prime Rate tends to rise when the economy is growing too quickly and inflation (the increase in the overall cost of goods and services over time and the reduction in the value of money) is going up faster than intended. The Prime Rate tends to fall when the economy is weaker, when financial markets are under pressure, and the government wants to stimulate growth. The Prime Rate tends to stay the same when the economy is growing at a reasonable pace and there is low, manageable inflation.
A variable interest rate loan is a loan in which the interest rate charged on the outstanding balance varies as market interest rates change. The interest charged on a variable interest rate loan is linked to an underlying benchmark or index, such as the Prime Rate.
When considering loan types, look at how you might benefit from a variable rate loan. The advantages of your interest rates rising with time typically manifest in the short, not long, term. They include:
Consider some of the below disadvantages of a variable rate business loan. These drawbacks pertain primarily to the prime rate – and thus your loan’s interest rate – increasing. Such increases do happen, as inflation, which has been consistent in previous decades, increases the prime rate. However, future decreases in the prime rate aren’t wholly infeasible, and these shifts would counter the below drawbacks.
Fixed rate small business loans have an interest rate that does not change during the life of a loan, which means you generally pay the same amount each month. With a fixed rate loan, the interest you owe per month would only change if you refinance your loan. In that case, you’d pay less interest if your monthly payments become smaller, and more interest if your payments become bigger. But the actual interest rate will remain the same.
Examples of fixed rate loans include:
With a fixed rate loan, you won’t get any surprises. You’ll always know exactly how much interest you owe with each of your payments. Just multiply your payment amount by your interest rate to determine your debt. Even if your payments vary in size, this interest calculation remains quick and simple. Some more advantages include:
A fixed rate might not be for you based on some of the following reasons. The first reason isn’t super likely (but isn’t impossible either) given that inflation, and thus the prime rate, typically increases with time. The second may seem counterintuitive but is indeed the prevalent trend when you compare and contrast fixed and variable rate loans. The third reason is perhaps the most straightforward.
When weighing variable versus fixed rate loans for your small business, weighing a handful of factors can help you come to the right decision. These factors may look different for every loan and every business. Take your time assessing your situation and loan options, and you should be on your way to making the right choice. Some factors to note are:
Make sure you’re working with a trustworthy lender, one that has a track record of successful fundings, with stellar customer service. Some additional questions to consider are:
Review the entire loan package and determine the best fit to strengthen your finances, and seek out a lender with stellar customer service. You’ll want to work with a knowledgeable loan specialist who can clearly and thoroughly answer all of your questions.