How High Interest Rates Affect Small Business Loans
The outbreak of the global pandemic had drastic and lasting effects on the economy, leading to job losses and business closures. In order to support those who had lost their jobs and businesses, the federal governments of Canada and the United States injected a significant amount of money into the economy in the form of subsidy packages and loans.
While these measures alleviated financial pressures for many, inflation levels skyrocketed. Now in an attempt to manage inflation, the Federal Reserve and the Bank of Canada have increased interest rates. Even though interest rate hikes may be necessary to curb inflation, it creates additional challenges for business owners.
This is especially true for small businesses who, as interest rates rise, are affected more severely than large corporations because they do not have the same financial resources to address these challenges.
How Rising Interest Rates Impact Small Business Loans
High interest rates can be a major hindrance for small businesses when it comes to financing their operations. When interest rates are high, it becomes more expensive for them to borrow money. This can put serious constraints on their financial planning as they are likely to take out smaller loans and unable to capitalize on opportunities that arise due to not having adequate resources.
The higher interest rates rise, the more of a limiting factor they become for small businesses looking to qualify for loans. Lenders are more cautious when interest rates are higher, which could mean greater scrutiny and more stringent requirements for those attempting to borrow money. Small businesses, particularly those with lower credit scores and limited collateral, will find it challenging, if not impossible, to qualify for a loan under such interest rate conditions.
High interest rates are also detrimental to the cash flow and profitability of small businesses. If a loan was taken out at a high interest rate, the business will have to devote a larger proportion of its revenue to paying off the interest, rather than investing in other areas, such as marketing and employee training.
How this Trickles Down
Rising interest rates affect businesses in both predictable and unanticipated ways. Here are a few examples of how businesses can suffer when too much revenue is eaten up by interest payments.
The labor shortages that have pervaded a number of industries since the onset of the pandemic are made worse for small businesses when interest rates are high. In a climate where there are too few workers to fill open positions, having competitive compensation packages are crucial to attracting and retaining employees.
Money that gets eaten up by higher interest rates can’t be used to pay employees, and so small businesses are finding themselves understaffed and in a struggle to keep their operations running smoothly. Where the worker shortages are concerned, small businesses are especially disadvantaged in industries where they must compete against large companies.
Trouble Forecasting Inventory Needs
When small businesses are faced with a decrease in capital due to higher interest payments, inventories tend to suffer. Without enough cash on hand, businesses can’t be as proactive when it comes to restocking needed supplies or simply increasing their inventories. This often results in delays which take their toll on small businesses in the form of bad reviews and poor customer retention.
When capital is tied up in loans and interest payments needed to combat inflation and keep small businesses afloat, growth, which is often financed through debt, ceases to be an option.
This can lead to stagnation where businesses are unable to expand or innovate. And when this issue expands beyond individual businesses, it can have a negative impact on entire industries and sectors.
Steps for Mitigating the Effects of Interest Rate Hikes
Despite these difficult circumstances, there are several steps that small businesses can take to mitigate the impact of higher interest rates on their finances.
Consider Fixed-Rate Loans
Fixed-rate loan options can provide small businesses with peace of mind, especially in challenging economic environments. Unlike variable rate loans, a fixed loan’s rate remains the same over the course of a loan’s lifespan, meaning there are fewer surprises when it comes to loan costs.
This can offer an additional layer of protection for small business owners who may be concerned about an ever-changing interest rate environment. Furthermore, these loans create predictability and stability within budgets because businesses can get a better idea of exactly how much their monthly payment costs.
Improve Credit Scores
Small businesses that have a better credit score may be eligible for more appealing loan terms. This can provide them with the opportunity to take advantage of loan offers that weren’t available to them previously.
To improve their credit score, business owners should develop a strategy that focuses on paying bills on time and reducing debt balances, as well as maintaining a healthy credit utilization ratio. While loan terms are not guaranteed, having a strong credit score can certainly increase the likelihood of being approved for a loan, and perhaps even accessing loan terms with lower rates and other incentives.
Consider Alternative Lending Sources
In this period of interest rates increases, small businesses are feeling its effects much more than large companies and corporations. It is therefore an imperative for small businesses to have options outside of traditional loans and methods of financing.
Accord offers small business loans, factoring, asset-based lending and a variety of other financing solutions to help small businesses to medium-sized enterprises (SMEs) overcome difficult economic circumstances and achieve their growth goals.
Contact us today to start your business on a path to financial success.