How Federal Interest Rate Hikes Affect Your Startup

by Creating Change Mag
How Federal Interest Rate Hikes Affect Your Startup

With all the tasks that come with starting a new business—managing the books, acquiring customers, ensuring positive cash flow and so on—it can be a challenge to stay on top of all the macroeconomic changes that may affect your business.

How many startup entrepreneurs, for example, could spare the time this week to watch and digest the congressional testimony of Federal Reserve Chairman Jerome Powell?

But if you are a startup and navigating your way through the world of business financing, you may want to take a closer look at federal interest rate hikes and see how they may potentially affect your future decisions.

Powell said that, depending on economic data, the Fed might raise interest rates higher and faster than officials had projected last year. That could lead to a federal funds rate with a range of 5%-5.25%

How rate hikes will affect your startup

So, what does that mean?

While the Federal Reserve increasing rates has widespread impact from real estate owners to consumers and other businesses, the beauty of being a startup is you’re a startup! You are a new company and decisions that you make on financing are typically for your first business loan as a new business.

This means you get to avoid the impact of a rate increase, since you don’t have an existing rate of payment to think about. However, what you need to be thinking about is what happens to your loan if the Federal Reserve raises rates after you get your loan.

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1.    Do you have a fixed-rate loan or a variable rate loan?

If you’re paying off your loan at fixed interest rates, the Fed rate hike won’t likely impact you. Your interest expense remains the same and your monthly payment doesn’t change.

On the other hand, if you have a variable rate loan, you’re going to feel the difference overnight. Those who took out adjustable rate loans are at risk of getting a big surprise when their lenders charge them with the new federal reserve interest rate.

Variable rate business loans will be adjustable monthly, quarterly or annually, which means your interest rate will change and directly impact both your interest expense and your payment.

At this point, you have to revisit your financial forecasts and see how you can manage the upcoming interest surges.

2.    You’re going to pay more in interest

If rates go up, so does your interest expense. Interest is typically charged on the average outstanding monthly principal balance of your loan, therefore if rates go up so will your interest cost. Make sure you have enough margin in your business to support the margin compression due to higher interest expense.

3.    Your payment is going up

For a startup, cash flow is king and any impact to daily cash flow can have a big effect on a new business. When rates go up, your payment will go up, which means you will be responsible for a larger payment monthly. If you have an existing loan, keep an eye on your rate adjustment period to make sure you are prepared for the increased payment.

Here is an example:

Before Rate Hike  

After Rate Hike

Principal balance $100,000.00 Principal balance $100,000.00
Interest rate 3% Interest rate 3.5%
Term (years) 5 Term (years) 5
Monthly payment $1,796.87 Monthly payment $1,819.17

4.    Start exploring other financing options

Considering that small business loans are already getting a bad rap with the new fed interest rates, now is the time to inquire about alternative funding solutions for startups.

Lending options such as invoice factoring will be beneficial to your business since they do not require you to take on debt. There’s also a business line of credit, which allows startups and small business owners to pull out funds from their accounts and pay them back with interest.

Ideally, if you don’t urgently need financing but you need sufficient funds for equipment repairs or other emergencies, you could opt for a credit line from your lender.

5.    Traditional lenders may potentially ease their qualification requirements

When the fed interest rate is high, it can have a net positive impact on business owners in the short term.

Following the Great Recession in 2008, traditional banks all but closed their loan offerings to small businesses citing high risk and low profit margins. With increasing rates, banks will begin to offer loans to small businesses increasing competition against alternative lenders.

6.    If you’re planning to get a small business loan, do it sooner rather than later

While you might not feel the impact of the federal interest rate hike now. If this trend continues over the next couple of years it will affect small business loan rates. It’s one reason to take a look at applying for a business loan now rather than later.

Here are some tips to think about:

  1. Keep your margins high enough to support higher interest expenses.
  2. Make sure you have enough working capital to support higher payments.
  3. Ask your lender for a longer term to lower your current payment.
  4. Lock in a fixed rate or a rate ceiling so you can have better control of future interest expense.
  5. Borrow less if you don’t need all the money. This, of course, has a direct impact on monthly payment and interest expense.

The bottom line

Even though startups and small companies will feel the impact of the Federal Reserve interest rate hike, you need to look at the broader picture. As interest rates are increasing, consumers tend to save because their returns from savings are higher. With less disposable income being spent, the economy slows and inflation decreases.

With the upcoming changes to the market and the Federal Reserve not giving a clear signal on how many times they’re going to raise the rates in 2022 and beyond. You may want to decide if it makes more sense to get a loan today while the rates are low or take the chance in the future with them being higher.

Remember that the rate you get will still vary on a number of different factors such as your credit score, your industry, and length of time in business.

Now is the time to revisit your financials and look at your long-term growth plan and decide on the best decision for your business.

This post was originally published in February 2022.

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