An interest rate hike is on the immediate horizon. There’s a 52% chance the Federal Reserve will raise the federal funds rate as soon as mid-September, at its next policy meeting. For small-business owners, this will increase the cost of small-business loans and may affect bottom lines.
The federal funds rate — the rate banks charge to lend federal funds to other banks — was 0.14 as of Aug. 5, according to the New York Federal Reserve. Perc Pineda, senior economist at the Credit Union National Association, tells NerdWallet the rate could be as high as 1.75% by next year.
“Don’t panic,” says Bruce Vandegrift, vice president at Rockford Bank and Trust in Rockford, Illinois. “You have time to manage your affairs to accommodate these changes.”
Here are three things small-business owners can do to prepare for a rate hike.
Repay or refinance high-cost, variable-rate debt
The annual percentage rate (APR) — or total annual cost of a loan, such as a credit line or adjustable-rate mortgage — may change based on the prime rate. The prime rate is generally around 3% higher than the federal funds rate. It was 3.25%, so if the funds rate jumps to 0.50, it could rise to 3.5% or higher, according to Pineda. (The Federal Reserve increased the federal funds rate by 0.25 percentage points on Dec. 16, 2015. The prime rate is now 3.5%.)
A higher federal funds rate means higher costs for variable-rate borrowers.
If a credit card charges 8% plus the prime rate, or 11.25%, the APR could be 11.5% come September. This only amounts to $25 more per year in interest on a $10,000 balance. But with larger increases looming for the prime rate, this debt will only get costlier, so it’s smart to pay down credit cards, says Vandegrift.
“Unfortunately, a lot of entrepreneurs finance short-term costs on credit cards — those are almost always the highest short-term rates you can get,” says Vandegrift.
Repaying your credit card debt might also improve your personal credit score, as your credit utilization ratio makes up 30% of your score.
Borrowers with adjustable-rate mortgages should find out when the loan’s interest rate resets and what the effect will be on payments, Vandegrift says.
“If you know you’re going to face a reset and you expect rates to continue to rise,” he says, “you have an incentive to refinance to a long-term fixed rate.”
Negotiate a fixed-rate loan
“If you could lock into a long-term fixed rate today or in the next month, as opposed to a variable rate, you’d actually be in a good position,” Pineda says, “because now we know higher interest rates are actually inevitable.”
If you got your small-business loan through an online alternative lender, rising rates are less likely to affect your costs.
A 0.25 point increase would change the monthly payments on a $100,000 loan with a 10-year term from $1,110 to $1,123, according to Evan Singer, general manager at SmartBiz.
Online lender Funding Circle doesn’t use the prime rate to set its interest rates and has no plans to adjust its rate, according to spokeswoman Liz Pollock. Peer-to-peer lender Prosper offers fixed-rate loans based solely on an applicant’s personal credit score, and Dealstruck only uses the prime rate to set rates on its line of credit, according to Dealstruck CEO Ethan Senturia.
But rising rates will affect the cost of U.S. Small Business Administration loans originated through SmartBiz. The company provides rates of 2.75% to 4.75% plus the prime rate, or 6% to 8%. A 0.25 point increase in the prime rate means borrowers will pay 6.25% to 8.25%.
This would change the monthly payments on a $100,000 loan with a 10-year term from $1,110 to $1,123, according to Evan Singer, general manager at SmartBiz.
To compare online small-business loans, check out NerdWallet’s Best Business Loans charts.
Put extra cash to good use
Here’s the good news: A rate increase will result in a higher yield on savings accounts, certificates of deposit (CDs) and money market accounts.
If you have money sitting in a checking account, earning little or no interest — and no plans to reinvest that cash into your business — consider transferring funds to an interest-bearing account.
“Ultimately, as short-term rates increase, maintaining your liquidity wisely will be a good decision,” Vandegrift says.
To get more information about funding options and compare them for your small business, visit NerdWallet’s best business loans page. For free, personalized answers to questions about financing your business, visit the Small Business section of NerdWallet’s Ask an Advisor page.
The post was updated to reflect the new prime rate as of December 2015. It was originally published Aug. 12, 2015.
Image via iStock.