Fixed vs. Floating Rate Loans
Examine the following financial characteristics, business needs and economic trends before deciding on business loan with a fixed or floating rate:
1. Interest Rate Trends
Economists are predicting low interest rates to continue in end of 2011 after which interest rates will start rising again.* A floating rate on a business loan converted into a fixed rate takes advantage of imminent rate decreases while giving the borrower an opportunity to lock in a low rate after a period of one to two years. Over the next year when interest rates bottom out, entrepreneurs should apply for business loans with fixed interest rates in case the Fed increases rates. Repeated Fed rate cuts (for at least three quarters) indicate that interest rates have bottomed out. Similarly, when the Fed stops raising the interest rates for two to three quarters, it means rates are on their way down and it may be an opportune time to apply for a business loan with a floating interest rate.
2. Cash Flow Needs
Generally, floating interest rate business loans require lower (anywhere between 50 to 75 basis points) initial payments than fixed rate products. This frees up cash flow for startup companies or other businesses with large initial costs or break even periods like franchises or security services. Enterprises like hotels and restaurants that have large initial capital outlay should also take a business loan with floating rates.
Fixed interest rate business loans provide more capital support for needs like expansion plans or refinancing, especially in a rising interest rate environment. Businesses with low initial outlay like real estate brokerage and advisory business require consistent money for marketing and meeting payroll expenses. Such enterprises should apply for business loans with fixed interest rates.
3. Time Horizon
In selecting a business loan product, the owner needs to consider how long they want to keep the business, their exit strategy and the types of improvements they can make to increase the business valuation. This will help them choose a business loan based on prepayment penalties. For example, normally an SBA-backed business loan has three years of prepayment penalties. If somebody is planning to refinance or sell a business within three years, they will have to pay the penalty. Other product lines like conventional commercial asset-backed business loans may provide a longer fixed rate term and prepayment penalty period.