What The Federal Interest Rate Change Means For Small Business

What The Federal Interest Rate Change Means For Small Business

In addition to the decisions and strategies implemented by a small business, there are also external factors that impact the financial decisions of small business owners. One the more significant factors is the current interest rate and the actions of the U.S. Federal Reserve to determine interest rate change.

The Federal Reserve chose not increase their rate during the Federal Open Market Committee meetings on March 15th and 16th 2016. The Federal Open Market Committee is the Federal Reserve’s policy-making committee. The committee meets again in April and then in June. However, analysts and investors do not expect another interest rate change until June 2016.

The plan, however, was originally for the Committee to raise its benchmark rate about one percentage point, most likely in four quarter-point increments. But federal officials delayed those plans after financial conditions tightened in January because of concerns about the health of the global economy.

The move went over well with investors. When the Fed made its announcement that there would be no interest rate change, the Standard & Poor’s 500-stock index rose sharply and closed up 0.56 percent for the day. After a rough start to the year, the major stock gauges had almost recovered their losses.

The Federal Reserve and Small Business

The Federal Reserve, or the “Fed” as it’s commonly called, impacts how much currency is in circulation, any interest rate change for institutions lending money, and is responsible for controlling the country’s monetary policy.

One of the main ways the Fed maintain its monetary policy is their benchmark short-term interest rate. This rate ultimately impacts everything from the price of groceries cost to the ability for businesses to hire new employees. Any increase or decrease in this rate inevitably spurs a subsequent interest rate change across the board.

Why is this?

Because high interest rates means it costs businesses more to borrow capital, while low interest rates make it cost less. At the height of the Great Recession, the Fed lowered its interest rate to near zero for the first time in U.S. history.

The Federal Open Market Committee did this in response to the fact that credit had dried up, and they hoped to spur bank lending to stimulate the economy. It took a long time for some semblance of economic recovery to come about and, during this time, interest rates have stayed at 0.0-0.25 percent.

The Fed kept its own interest rates at this level from December 2008 until December 2015 when it made an interest rate change from 0.0-0.25 percent up to 0.25-0.5 percent. During this seven-year period of near-zero rates, a large number of small businesses opened and closed their doors, while many entrepreneurs launched new enterprises and the economy slowly improved.

How Does This Benefit Small Businesses?

As previously noted, when an interest rate change results in an increase in rates, capital becomes more expensive, which means those owners looking for a small business loan may end up paying more in the long run.

However, many alternative lenders such as online lenders are not bound by this rate the same way traditional banks are. This can provide many more options for small business owners looking to access capital.

According to some analysts the decision not to hike rates could bring additional economic woes. However, despite some uncertainty in certain sectors regarding the central bank’s decisions, the bottom line is that small businesses can benefit from pursuing a working capital loan if necessary.

What Are No Collateral Business Loans?

What Are No Collateral Business Loans?

When you want to grow your business, obtaining a small business loan is a common approach for making it happen. However, there are a variety of loan types that can be considered, including “no collateral business loans.”

No collateral business loans can be defined as loans that utilize a borrower’s promise to pay as security, versus a physical or tangible instrument of value. In a collateralized loan, like a car loan, failure to pay means that a lender can repossess the item used as collateral. With no collateral business loans, however, no physical item is placed as security for the new loan.

As many small business owners have discovered the hard way, in order to get, sometimes you have to give. This is especially true when it comes to obtaining loans. Oftentimes lenders will require owners to pledge collateral against a loan. Lenders use secured loans as a way to cover their bases in case the borrower defaults.

This way, even if a business owner is unable to pay back their loan, the lender has some recourse in the form of selling whatever asset has been pledged to cover the costs. However, this isn’t always a viable option for business owners, which is why unsecured, or no collateral, business loans may be the ideal alternative.

The Versatility of No Collateral Business Loans

The benefits of both collateralized and no collateral business loans are distinct. Loans involving the use of collateral will typically have lower interest rates and longer terms, which can provide a low payment. No collateral loans are usually of a shorter term and have a higher interest rate. This can drive up the overall cost of the loan because of significantly higher risk business loan to the lender.

No collateral business loans, however, are versatile loan offerings that can be used for practically any purpose. An example is using a no collateral loan to pay outstanding business taxes. By taking out a small, no collateral business loan, taxes can be paid and any collection efforts stopped.

No collateral business loans are also great for small business owners looking for direct capital to expand or improve their businesses. This is because there is no chance that they will lose their personal assets in a worst case scenario.

The Downsides of Unsecured Business Loans

There are a few issues associated with unsecured loans that can make them less than ideal for many small business owners.

No collateral business loans are difficult to get from traditional banks. For one thing, loans with no collateral requirement are inherently higher risk for banks, which means there are exacting standards for applicants and they will often disqualify business owners due to “high risk loan” business models, bad credit, and other issues.

Additionally, unsecured funding will have higher interest than other programs and rigid payback structures that can put excessive strain on business cash flow.

Business owners may find that because of the difficulties getting approved for no collateral business loans, they may not even be eligible for the funding they require. Even if they are approved, they may be lumped into a generalized program that is not accommodating to the needs of their unique business.

Alternatives for Business owners

Premier Business Lending understands today’s small business owner and their financial needs. Our goal is to help navigate your business through today’s financial marketplace while providing long term financial solutions and support for the small business.

Everyday small business owners deal with the daily stresses of running their businesses. And because of unexpected economic challenges, or business opportunities, there are many times in which additional capital is a real need. We provide quick online lending along with loan terms as short as three months and as long as five years. Premier Business Lending has become a significant resource for today’s medium to small business owner.

How To Calculate Business Loan Fees

How To Calculate Business Loan Fees

If you’re starting a business or looking to grow your existing business, a small business loan may be a viable financial strategy. Keep in mind that when you repay a small business loan, however, you’ll end up paying more than the amount borrowed because of interest, amortization, and business loan fees.

All small business loans come with interest that the borrower pays to the lender and loan rates can be varied or fixed.

Variable rates change over time as market interest rates shift. If market rates are high, a variable rate can be a good idea since the loan rate will decrease if market interest rates drop.

Fixed rates lock in the market interest rate at the time a borrower takes out the loan. If market rates are low, it’s wise to get a fixed rate and maintain that low interest rate throughout the duration of the payment schedule.

Understanding Amortization

The loan’s term, or how long it takes to pay off, affects the overall cost of the loan because it determines how long interest is paid. This is known as amortization which can be defined as the gradual repayment of a loan in equal (or nearly equal) installments which include portions of interest and principal amounts.

Although interest is not typically considered in the same category as business loan fees, it is still part of your cost for borrowing a sum of money. Calculating your amortized interest payments is done with a payment, or amortization schedule. This is a plan for paying back a loan in regular monthly increments.

Each payment consists of principal and interest. For example, assume you have taken out a $100,000 loan for five years with a 5% interest rate. Each month, you’ll repay $1,887.12 in principal and interest.

At the beginning of the term, the larger portion of your payment is interest. Consequently, $416.67 of your first payment is interest and $1,470.46 goes towards the principal.

With each payment, the interest portion decreases and the principal payment increases. In our example the interest amount has decreased by $6.13 on the second payment and the principal portion increased accordingly:

Business Loan Fees Calculation

In the final month, you would only pay $7.83 in interest and $1,879.29 in principal to pay off the loan.

Looking at Other Typical Business Loan Fees

As a borrower you will also have to pay business loan fees. Most common are origination and guarantee fees, but some lenders will have additional costs. Often you will have to pay interest on any fees that are added to the loan rate. This increases not only the amount loaned, but the total interest charged as well.

Origination fee – An upfront fee that is charged for processing a new loan. Lenders charge borrowers this fee for processing a loan application and other administrative work involved. It’s taken as a percentage of the total loan, for example, 1% of a $100,000 loan.

Guarantee fee – For SBA-guaranteed loans, lenders pay the government a portion of the amount guaranteed. Many lenders pass on part of this cost to the borrower.

Underwriting fees – These are business loan fees collected by underwriters who verify and review all of the information you’ve provided.

Closing costs – These business loan fees can include other costs associated with servicing the loan such as a loan-packaging fee, a commercial real estate appraisal or a business valuation.

Unfortunately, business loan fees are unavoidable and can add a significant amount of money to your loan. Each lender should give you a list of what each fee includes and should explain any fees that you don’t understand.

Business Loan Principal vs Interest: What's The Difference?

Business Loan Principal vs Interest: What’s The Difference?

Most small businesses are unable to make major purchases without taking out business loans. Understanding how the loan process works is important for business owners and others looking to take on a loan. This includes having a clear understanding of principal vs interest.

Businesses must pay interest, which is simply a percentage of the amount loaned, to the institution that loans them the money. These loans could be for vehicles, buildings, or other business needs. The amount loaned is what is called principal, or the actual loan amount.

How Interest Is Calculated for a Business Loan

Banks actually use two types of interest calculations:

Simple interest, which is calculated only on the loan principal vs interest accrued on amount of the loan, which is how compound interest is calculated. In other words, on both the principal and on interest earned.

Simple interest is the simplest formula to calculate. Here’s an example of simple interest where “n” represents the life of the loan:

Principal × interest rate × n = interest
To show you how simple interest is calculated, assume that you borrowed $10,000 from the bank for a building loan at five percent (0.05) interest for four years. When the loan principle is repaid after four years, the interest accrued is two thousand dollars, or $10,000 × .05 × 4 = $2,000.

Notice that the total interest rate on the balance vs interest paid is determined by the life of the loan. In theory, if the loan were repaid in full in only two years the total interest accrued would only be $1,000.

Compound interest, on the other hand, is not computed on just the principal vs interest accrued like the previous example. The interest per period (monthly or annually) is based on the remaining principal balance plus any outstanding interest already accrued. The total loan interest compounds over time.

Types of Business Loan Repayment Plans

You and your lender can potentially arrange for a number of repayment plan options. Let’s say you borrow $10,000 with interest at the rate of 10% a year. Here are some of the more common business loan repayment possibilities:

Lump sum repayment: You might agree to pay principal and interest in one lump sum at the end of, say, one year. Under this plan, after 12 months you’d pay the lender $10,000 in “principal”, or the borrowed amount, plus $1,000 in interest.

Periodic payments of principal and interest: You would repay $2,500 of the principal vs interest amounts that decrease at the end of each year. Under this plan, your payments would look like this:

Year one you pay $2,500 of the principal plus $1,000 interest.
Year two you pay $2,500 of the principal plus $750 interest.
Year three you pay $2,500 of the principal plus $500 interest.
Year four you pay $2,500 of the principal plus $250 interest.

Amortized payments: This type of arrangement requires you to make equal monthly payments so that principal and interest are fully paid in a certain time period. Under this plan, you’d have an amortization table to figure out how much must be paid each month to fully pay off a $10,000 loan principal vs interest of 10%.

Each of your payments would consist of both principal and interest. At the beginning of the repayment period, the interest portion of each payment would be larger and decreasing towards the end.

Know What You Owe

To sum up, a business loan is a simple matter of paying the full amount of the principal vs interest amounts, which can vary not only in the percentage applied, but in the manner it’s calculated. Once you are ready to move forward with the loan process, be sure you know how much the interest is going to add up to in an actual dollar amount over the life of the loan.