Choosing Fixed- or Variable-Rate Business Financing
By Rick Dennen
Traditionally, commercial borrowers have had limited options in the type of financing available to meet their business needs. Whether the purpose was for business growth or simply boosting working capital, many lenders have not tailored their financial products to borrower’s requirements. For borrowers, that usually meant variable rates that were based off of benchmark indices such as the prime rate. Unfortunately, the inherent volatility of those indices often made it difficult to ensure cash flows are sufficient to repay your obligations.
Today’s rate environment has led to another option for business borrowers. With key benchmarks at historic lows, now may be the time to lock in these low rates. The desire to respond to market conditions and meet the financial borrowing needs of many customers, some lenders are now starting to offer something that would have historically been unaffordable for customers: fixed-rate commercial loans.
Until recently, if you needed to borrow money to finance an opportunity, your business could choose from several loan types, primarily incorporating a variable-rate structure. In most economic environments, variable-rate loans offer some substantial advantages for businesses. Frequently, these loans are structured with promotional rates for an introductory period, making initial payments more affordable. Lenders are typically willing to extend larger amounts through a variable-rate loan because it reduces the amount of interest rate risk the lender has to assume.
However, conservative business owners may be uncomfortable with the idea of borrowing money for the long term with no predictability for rates and as a result unpredictable monthly payments. If inflation returns with a vengeance three years into a ten-year variable-rate loan, the owner could see a significant jump in payments for the balance of the loan — perhaps enough of a jump that the original investment no longer makes sense. And, while loan agreements typically specify that rates can increase when the underlying indices go up, they don’t always allow as much movement in the opposite direction, so even if market rates take a steep drop, your loan rate may remain higher.
The biggest advantage of fixed-rate lending is the predictability. You are able to borrow with the confidence that your rate and monthly payments will remain unchanged for the life of the loan. If inflation becomes a major issue and market rates increase, your payments will remain flat. Of course, if market rates should drop, your rate may be less of an advantage, but it’s hard to imagine that market rates could fall too far below current levels.
The availability of longer-term loans at fixed rates means businesses can make a longer-term commitment without having to worry that their rates may increase several years down the road. The rate and the monthly payment will remain level across the life of the loan, because the lender is agreeing to assume all the interest rate risk.
These long-term fixed-rate loans are a boon for business owners who are contemplating a significant expansion, such as the acquisition of another business, or any major capital investment. If that expansion or investment leads to continuing revenue growth while the interest rate and monthly payments remain flat, the loan becomes that much more affordable with each month.
So would your business be better off with a fixed- or variable-rate loan? The right choice for your company depends upon why you are borrowing, your company’s financial condition, your own risk tolerance, and your predictions about how the interest rate environment might change in coming years. You can also use our interactive loan calculator to compare fixed- versus variable-rates. If you’ve been thinking about taking advantage of today’s lower rates to finance a major change to your business, now may be the perfect time to act, and fixed-rate loans might be worth a closer look.
About the author
Rick Dennen is President and CEO of First Commercial Finance, a division of First Financial Bank, which operates under the brands of Oak Street Funding and First Franchise Capital Corporation. As founder of Oak Street Funding, Rick led the specialty lending company from a business concept in 2003 to the nation’s top insurance lender. Since then Oak Street has expanded its lending offerings to registered investment advisors (RIAs), certified public accountants (CPAs) and indirect auto finance companies. In addition, Oak Street offers third-party loan servicing to multinational bank portfolios and backup servicing to securitized portfolios.
Rick earned both a Bachelor of Science in Accounting and a Masters of Business Administration from the Indiana University Kelley School of Business. He is a licensed Certified Public Accountant in Indiana, as well as a licensed agent for Life, Accident and Health products in Indiana. Rick has spoken at conferences, universities, seminars and other events. He can be reached at firstname.lastname@example.org.
The materials in this article/blog are for informational purposes only. They are not offered as and do not constitute an offer for a loan, professional or legal advice or legal opinion and should not be used as a substitute for obtaining professional or legal advice. The use of this paper, including sending an email, voice mail or any other communication to Oak Street, does not create a relationship of any kind between you and Oak Street. Loans and lines of credit subject to approval. Rate may vary at any time. Potential borrowers are responsible for their own due diligence on acquisitions. CA residents: Loans made pursuant to a California Department of Business Oversight, Finance Lenders License (#6039829).