How Rising Interest Rates Affect Small Business Loans

Mortgage interest rates have been at or near record lows for the past several years, but experts are predicting that rates will see definite increases this year. As mortgage rates rise, other rates, like those on small business loans, often rise as well. A jump in rates can affect both current small business loans and potential ones.

1. Increased Cost of Debt

As rates rise, the amount of risk a bank faces can often increase. Most banks and lenders actually borrow money from other bigger institutions in order to lend to small business owners. So when interest rates rise, lenders must pay out more money in interest to their creditors. This increases their debt-to-equity ratio and they pass on those costs in order to lower their credit risk. That means those with existing loans and lines of credit with variable rates will see their loan costs rise as well.

Those with current small business loans can try to refinance into fixed-rate loans. The rates will never increase on these loans but it usually requires a significant amount of cash upfront. If refinancing is not an option, business owners can help reduce the burden of rising rates by sticking strictly to the loan terms and paying on time to avoid even higher rates.

2. More difficult to obtain a new loan

For those looking to obtain a new small business loan, higher rates may make it more difficult as the borrower’s ability to make loan payments is one of the key qualifications. When rates are higher, payments increase, reducing how much a business owner could borrow or afford.

Potential borrowers can make themselves more attractive to lenders by producing profit-and-loss statements as well as cash flow statements that prove they can make payments at current rates as well as at higher rates if possible. And of course, being able to show that the money will be used for business growth and not just to cover debts is helpful.

Lenders and borrowers can sometimes feel squeezed as interest rates rise, but by being prepared the pain can be minimized.

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