When it comes to financing your business, understanding the difference between fixed vs. variable interest rate loans is critical to making the best decision. Both loan types offer distinct advantages and challenges depending on your business’s financial health, growth plans, and risk tolerance. In this article, we’ll break down the key differences between these two types of loans and explore which option may be better for your business.
What Are Fixed Interest Rate Loans?
A fixed interest rate loan has an interest rate that remains constant throughout the life of the loan. This ensures your monthly payments stay the same, regardless of broader economic changes or adjustments by the Federal Reserve. The fixed rate is partly determined by Federal Reserve Fund Rates at the time of loan approval. Depending on the duration of the loan and market fluctuations a fixed interest rate loan can be beneficial or less ideal for the borrower.
Advantages of Fixed Rate Loans:
- Predictability: Since the rate remains the same, businesses can budget accurately, knowing that their payments won’t fluctuate.
- Long-Term Stability: Ideal for long-term financing where stability is essential, such as purchasing property or long-term equipment investments.
- Protection from Rate Increases: If market interest rates rise, your loan payments will not be affected, offering protection from unexpected hikes.
Disadvantages of Fixed Rate Loans:
- Higher Initial Rates: Fixed rates are often higher than variable rates at the start, leading to higher initial costs.
- Limited Flexibility: You won’t benefit if interest rates fall, as your loan payments will remain locked in at the original rate.
What Are Variable Interest Rate Loans?
A variable interest rate loan, also known as a floating or adjustable-rate loan, has an interest rate that fluctuates. The rate typically in relation to an index such as the prime rate. The interest rate can increase or decrease throughout the loan term, based on market conditions.
Advantages of Variable Rate Loans:
- Lower Initial Rates: Variable rate loans often start with a lower interest rates than fixed-rate loans, reducing early payment costs. Keep in mind that most variable interest rates will be based off the prime rate plus an additive rate.
- Benefit from Falling Rates: If interest rates decline, your loan payments will decrease, allowing for cost savings over time.
- Shorter-Term Needs: Variable rates can be more advantageous for shorter-term borrowing where the risk of rising rates over time is less concerning.
Disadvantages of Variable Rate Loans:
- Unpredictability: Payments can fluctuate significantly, making it harder to budget for long-term financial planning.
- Exposure to Rate Increases: If interest rates rise, your monthly payments can increase, potentially straining your business’s cash flow.
What’s better for your business?
The decision between a fixed or variable interest rate loan depends on several factors, including:
Your Business’s Risk Tolerance:
If your business prefers financial predictability and stability, a fixed-rate loan may be the safer option. Conversely, if your business can manage payment changes and you believe interest rates may fall over the duration of the loan, a variable rate loan could be more attractive.
Current Market Conditions:
In a low-interest-rate environment, fixed rates may be appealing to lock in favorable terms. However, if rates are expected to decline, a variable rate loan could result in savings.
The SBA 7(a) Loan: Fixed vs. Variable
The SBA 7(a) loan, one of the most popular financing options for small businesses, typically offers variable interest rates. Though some lenders offer these loans with a fixed interest rate, it is uncommon. The rates are often tied to the prime rate, which means they can fluctuate over time based on Federal Reserve decisions.
For small business owners with SBA 7(a) loans, this means that as market rates fluctuate, your loan payments may rise or fall accordingly. With the FOMC (Federal Open Market Committee) expected to lower interest rates, now is an ideal time to secure an SBA 7(a) loan, as future rate cuts could reduce your borrowing costs.
If you’re looking for a small business loan, NEWITY can help. With our streamlined application, you can discover how much you are eligible to receive in 10 minutes. Just create an account and apply – it won’t affect your credit score!
Fund your business with an SBA 7(a) loan
