The Federal Reserve’s September quarter-point rate hike has brought borrowing costs back into focus. Bank prime is currently 7%, and even before the hike, the median variable rate on a new small business term loan was 6.7% at rural banks and 7% at urban banks, according to the Kansas City Fed’s Small Business Lending Survey.
A Fed rate hike raises the federal funds rate, which banks use to set their prime rate (prime sits 3 percentage points above the top of the Fed’s range). Most variable-rate business credit, including bank lines of credit and SBA 7(a) loans, is priced as prime plus a margin, so its cost rises soon after the Fed moves.
For business owners, founders, and CEOs, that begs a key question: What should an owner do before borrowing cash in a rising-rate environment?
Business financing specialists advise being more careful, creative, and disciplined when financing business operations in a Fed rate hike environment. These loan and credit money moves should get the financing job done with minimal downside impact.
1. Bring a Cash Flow Forecast to Every Lender
It’s a good idea to recast your financial documents when borrowing in a higher-rate business realm.
“Before you apply, walk in with a 13-week cash flow forecast, and not just last year’s tax return,” Anthony Guerriero, CPA, managing partner of Manhattan Miami Real Estate, and a former Deloitte senior manager, told SBG Funding. “Debt service coverage is the number the credit officer actually prices on, and most owners have never calculated their own. Know it before the bank does.” (Here’s how to work out your debt service coverage ratio.)
When it comes to leverage, cash flow and your debt-service coverage ratio (DSCR) are king right now. “Lenders care way more about steady, proven net operating income than they do about your optimistic revenue projections,” Idrees Khan, regional branch manager at Pacific Lending, told SBG.
2. Get at Least Three Quotes
After you cross that chore off your ‘to do’ list, get at least three quotes from lenders, Guerriero advised. “The spread between lenders on the same file is often bigger than anything you’ll negotiate with one of them.”
Khan agrees. “Your biggest immediate leverage is lender shopping. Never just take the term sheet from your primary bank. Pitting a local community bank against an SBA lender or an alternative platform is the fastest way to compress that spread.”
3. Borrow Only for Projects Worth the Higher Rate
When interest rates are ascending, make sure you’re borrowing for the right reasons.
“Traditionally, when we need to expand our working capital, we refinance,” Leon Schwab, owner at FairPrice Movers in San Jose, Cal., told SBG.
To do so effectively, Schwab tracks his outfit’s average cash flow over a fixed period.
“We look at our average cash flow because there are some seasonal fluctuations and because we have ongoing projects,” he said.
When lending rates rise, Schwab emphasizes the relationship between the cost of capital and the projects he wants to fund. “There are some projects like purchasing a new truck to go after a payable load that is worth funding,” he noted. “Other projects like a business rebrand are not worth funding.”
When his team shops around for lenders, Schwab takes special care to include banks.
“Because of the nature of our business, which includes multiple state operations with physical capital like trucks and equipment, we’re able to negotiate better terms,” he noted. “Other small businesses also shop around, but often borrow without considering the opportunity cost of the time spent managing the debt.”
4. Clean Up Your Books and Credit Before You Apply
Before even talking to a lender, an owner needs to look at their books the same way an underwriter will.
“Clean up your accounts receivable, knock down short-term revolving debt, and make sure your personal and business credit reports don’t have lingering surprises,” Khan said.
Historically, the most competitive lending rates are generally available to established business owners who have good-to-excellent credit.
“Lenders also want to see that your business has a healthy revenue flow and that you can manage the required debt payments,” Paul Ferrara, a senior wealth counselor at Avenue Investment Management, told SBG.
One upside borrowing strategy is offering collateral, which may help you qualify for a lower interest rate than you might receive with an unsecured line of credit. “Comparing offers and shopping around among lenders can also be an effective way to find a more affordable business line of credit,” Ferrara said.
5. Choose Fixed or Variable Rates, and Refinance Carefully
With a fixed-rate loan, payments remain the same because the interest rate stays constant. With a variable-rate loan, the lender may change the required payment amount when the interest rate changes. “One advantage of variable rates is that they can initially be lower than fixed rates, so the choice comes down to the financing structure and the certainty of payments,” Ferrara noted. (More on fixed vs. variable rates.)
If you’re already carrying debt, consider these factors. “Refinancing an existing business loan could help reduce interest costs, lower monthly payments, or help avoid a large balloon payment. But you should also check whether your current lender charges a prepayment penalty and consider how that additional cost could affect the value of refinancing,” Ferrara added. “If you’re already having trouble keeping up with payments, refinancing could instead lead to a cycle of debt that becomes difficult to get out of.”
Compare Your Options with SBG Funding
SBG Funding is a direct provider of revenue-based financing and a marketplace offering a broad range of funding solutions through an extensive network of lenders. One application lets you compare offers side by side, including fixed-payment options like our small business term loan, and applying doesn’t affect your credit score.
Get Started Today:
- Fill out our online application.
- Speak with a funding specialist to compare your offers.
- Submit your documents and receive funding quickly.
Typical Requirements:
- Four months of bank statements
- Minimum FICO score of 500, six months in business, and $150,000 in annual revenue
FAQs
It depends on the rate type. Payments on fixed-rate debt you already have don’t change. Variable-rate debt, such as most bank lines of credit and SBA 7(a) loans, is tied to the prime rate, so its cost rises soon after the Fed raises rates. New financing of either kind is priced off the higher rates.
A fixed rate locks in your payment, which protects you if rates keep climbing. A variable rate can start lower but can rise with each Fed increase. If certainty of payments matters more to your cash flow than the lowest starting rate, a fixed rate is usually the safer choice.
Mostly your ability to repay: steady cash flow, your debt service coverage ratio and your credit history. Bring recent bank statements and a short cash-flow forecast, and get quotes from more than one lender, since offers on the same file can differ widely.
