When researching small business loans, there are many things to consider, such as the term, the loan amount, and the interest rate. Interest rates can be fixed or variable, which is another important decision for your business, as the differences can be beneficial in certain situations, but detrimental in others.
What Is the Difference Between Fixed and Variable Rate Loans?
With fixed rate loans, your company is subject to the same interest rate throughout the term of the loan. This means your payment will remain the same every month.
With variable rate loans, your interest rate may fluctuate periodically during the loan term, depending on the market rates at the time. The interest rate is tied to an index that changes as the market moves. This means your monthly payment might go up or down during the term, depending on market activity. Typically, there is a cap to the amount of variability the rate can experience.
When Is a Fixed Rate Loan Preferable?
Having the same, reliable monthly payment can make it easier to budget, as your business will always know what to expect and can plan accordingly. If you are a planner or risk-averse, a fixed rate loan is probably a safer bet, as it eliminates a cause for potential anxiety.
When Is a Variable Rate Loan Preferable?
Often, businesses opt for a variable rate loan because the interest rate is significantly lower than the rates offered by fixed rate options. This is definitely enticing, yet it comes with an element of uncertainty. If timed correctly, the interest rate might always remain low, which could potentially save your business a lot of money. On the flip side, the rate could increase considerably. If your company is not financially prepared for this, it could negatively affect the business.
What Else Should I Consider?
When deciding between fixed and variable rate loans, think about the amortization period. If the loan will take longer to pay back, you'll have that much more of a chance of the rate increasing along the way.
Also, reflect on the market trends and what analysts are predicting for the future. If interest rates are at the start of a downward trend, a variable rate loan could be ideal. If interest rates are expected to start climbing, it is better to lock in a lower rate with a fixed rate loan. Understand that no market forecast is guaranteed.
Both fixed and variable rate loans can have fees associated with them. Make sure you read the fine print and understand all the costs involved with any loan. For example, a loan might have an origination fee or a prepayment fee if you choose to pay the loan off early.
Keep in mind that refinancing is sometimes an option. Of course, there will be fees associated with this process. But, often, refinancing a fixed rate loan is worth it because of the savings afforded when interest rates drop significantly. Similarly, if interest rates start rising, refinancing a variable rate loan to a fixed rate can help lock a business in to a stable payment it can more easily afford.
The decision to go with fixed or variable rate small business loans really boils down to your personal inclination toward risk or stability. Both come with potential advantages and disadvantages. Pick the option that best matches the strategies of your company.