During the pandemic last year, small businesses had access to loans through the Paycheck Protection Program, or PPP, with a 1 percent interest rate. As of May 31, 2021, the PPP is no longer accepting applications, and the window of opportunity to super low interest loans has closed. Does this spell the end of low interest loans for small business owners and nonprofits? Or can we expect a business-friendly environment to continue post-pandemic? And how will inflation affect interest rates? If these questions caught your attention, read on.
Current Interest Rates: Historic Lows
Small business loans in 2021 are near record lows. From January to July, a 20 year 504 loan averaged 2.884. To put that in context, in 2019 the average rate for the same loan was nearly double, at 4.168, and back in 2007 during the Great Recession, the average rate was 6.413. While 504 loans can only be used for major fixed assets, the dramatic difference in rates illustrates the current opportunity for businesses ready to invest in growth.
Will interest rates go up after the COVID-19 pandemic is over? Current rates are so low that this scenario is nearly guaranteed. So when is this rate increase likely to happen, and what are the driving forces?
To answer these questions, we need to get inside the mind of the central bank of the United States, the Federal Reserve. Founded in 1913, the Fed, as it is commonly known, is responsible for conducting monetary policy and stabilizing the nation’s financial system.
The Fed’s current policy is directed at achieving maximum employment with a long run inflation rate of 2 percent. In recent history, inflation has been below this rate, so Fed leadership is steering course for short term inflation levels above 2 percent to bring the average back up to this level. To accomplish this, in November, the Fed committed to keeping interest rates low “until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” As recently as March, the Federal Open Market Committee (FOMC), consisting of the seven members of the Federal Reserve’s Board of Governors and five of the bank’s presidents, forecasted that the inflation rate would average 2.4 percent in 2021, decreasing to 2.1 percent by 2023. Even though nearly fifty percent of the U.S. is now vaccinated against the coronavirus, the unemployment rate remains high. Many of the people whose jobs were cut during layoffs off at the height of the COVID-19 crisis decided to stay in retirement, or have not yet reentered the workforce. With unemployment hovering around 5.9 percent, Fed policies are unlikely to change for some time, meaning that interest rates are likely to remain low. But for how long?
According to the International Monetary Fund, or IMF, the first rate hike will likely occur in late 2022 or early 2023 as the central bank begins to cut back on asset purchases. This will signal the Fed’s transition from supporting and reassuring the economy, to a return to business-as-usual.
The good news in all of this? First, that interest rates are likely to remain low for at least one more year. And second, the U.S. economy is predicted to grow at an astonishing 7% in 2021, the fastest growth rate since 1984. Businesses that are poised to take advantage of this fast growth rate may gain an advantage that puts them ahead of the competition, while those that are too slow to recover and delay reopening may find themselves far behind when it comes to hiring qualified staff, investing in marketing, and recovering healthy growth. SBA loans are a time-tested way of ensuring that sufficient funding is available for business development needs.
Funding Sources to Consider
There are several options available right now for most businesses seeking cash flow, including Employee Retention Tax Credit, EIDL Grants, Working Capital Loans, Term Loans, and Commercial Real Estate Loans. If you’ve never gone through the application process for one of these loans, you may be surprised to learn that loan application approval can occur within twenty four to forty eight hours for qualifying businesses (depending on the loan type). Of course, you don’t have to do this on your own. The smartest business people are those who know when and how to ask for help. If you are not sure whether you are ready for a loan, or you are not sure which loans to consider applying for, seek the help of a trusted financial advisor who will help clarify your thinking and set you on the path to increased growth. You may even consider speaking with a business consultant who can examine your business model and help optimize your business operations so that when you receive funding, you are able to put it to good use.
Employee Retention Tax Credit
Under the American Rescue Plan Act, Congress has expanded the Employee Retention Tax Credit through December of 2021. Under the CARES Act, the tax credit was 50% on $10,000 in wages annually. That has now been expanded to 70% on $10,000 in wages per quarter (a maximum benefit of $14,000 per employee per year). This credit is also now available to companies who employ up to 500 people, where previously it only applied to companies with up to 100 employees. The expanded credit is also available to employers who previously took out a PPP loan, however it cannot be used for the same payroll expenses.
EIDL stands for “Economic Injury Disaster Loan,” but despite the name, this source of funding functions more like a grant than a loan, in that it does not have to be repaid. Unlike a typical federal grant, EIDL does not come with extensive red tape. EIDL funding is available in amounts up to $15,000, with priority being given to businesses in low-income areas with less than 300 employees and that experienced a 30% reduction in gross receipts during any 8 week period between March 2 and December 31, 2020, compared to the previous year.
Working Capital Loans
Working Capital loans offer flexible funding that can be used for a variety of short-term business-related purposes, including hiring, purchasing inventory, operating expenses, buying equipment, and even expanding your workplace. With some lenders, these loans are tied to the business owner’s personal credit score, which may pose a risk that you are not willing to take. These loans are frequently used to get a struggling business through a slow season while more sustainable solutions to cash flow problems are found. Repayment can be taken from business receipts, with payment schedules ranging from daily to bi-monthly.
Term loans are another popular option for growing a business, and are available in 12-, 18-, 24-, and 36-month increments. Repayment schedules can be weekly or bi-monthly, and funds can be used for a broad range of business needs. Plus, interest is tax-deductible.
Commercial Real Estate loans are larger loans that are secured by commercial real estate equity. Terms range from 12 to 36 months, and repayment is typically monthly. Because they are typically for a larger sum, they are often used for acquiring a new business, refinancing existing projects, or funding a renovation.
The 504 Loan Program offers fixed rate financing of up to $5 million for major fixed assets. These loans are offered through Certified Development Companies, or CDCs, with 10, 20, and 25 year terms available. To be eligible, you must be a U.S.-based for-profit company with a net worth less than $15 million, and an average net income less than $5 million after federal income taxes. These loans can be used for land or buildings, new facilities, and long-term machinery and equipment, or the improvement and modernization of these same assets.
7(a) Loans make up the Small Business Administration’s most popular lending program, as they offer funding for real estate, short and long term working capital, refinancing current business debt, and purchasing furniture, fixtures, and supplies, with a maximum loan amount of $5 million. As with other SBA loans, to be eligible you must operate for profit, do business in the United States, and use the loan for a sound business purpose, as demonstrated by a legitimate need your company has. Loan terms vary, but most are repaid through monthly payments.
Accurately predicting the future is a Herculean task, and even most economists are quick to admit that their forecasts are often wrong. While the timing suggested in this article may be off, and the rates may fluctuate more before finally settling back to a more typical range, the picture that the data paints remains clear: Whether you are a hungry startup or an established business seeking recovery and growth after the pandemic, if you have a solid business plan and a valid opportunity to take advantage of, this may be a good time to look into a loan.