When it comes to borrowing money to start or grow your business, choosing between fixed and variable rates is a key decision.
When I am asked where our economy is headed these days, my answer is simply this: Uncharted territories. There has never been a time in our history in which the U.S. government has printed this much additional money — literally trillions of dollars — to keep people from hunger lines and keep them alive.
We are at the end of that, and the dominoes, in the form of rising interest rates and slowing jobs growth, are seemingly beginning to fall. Will the rat-tat-tat of rising rates continue? Accelerate before it slows?
Are we headed towards a recession, or just a short-term market adjustment for a system currently dealing with a historic increase in our money supply? I believe it is the latter, that we are not headed to a recession, at least as they have been defined in the past.
That said, it is quite possible the Fed has another rate increase up its sleeve. And these are the twists and turns an upstart business needs to navigate correctly. Consider this actual case that I ran into recently. An entrepreneur borrowed $5 million from the Small Business Administration (SBA) at a variable rate that began at 6 percent and is now at 8.25 percent. He is nervous, and who can blame him? His balance is now $4 million, so he is mulling changing and borrowing from a commercial bank at a fixed rate of 6 percent.
Should he? On the surface, it appears to make sense. Rather than paying out say $600,000 per year, he is down to $550,000. But what is the price of that extra $50,000 in cash flow? Well, for one, restrictions. Commercial banks tend to restrict how much money their loan holder can take out of a business.
Another aspect to consider about a bank loan is that most have some stiff prepayment penalties. The SBA has no such prepayment restriction. Indeed, the SBA — formed to help the entrepreneur — offers loans with all types of protections that can help a young company navigate through uncertain times.
Ah, but there is the rub. That uncertainty could mean that a variable-rate loan bought from the SBA at 6 percent rises above 8.25, to 9 or even 10 percent, raising the cost of the original loan and decreasing valuable working capital.
Of course, the opposite could occur — what if the federal government decides it raised interest rates so much that it is adversely affecting the economy and starts knocking those rates down? That SBA variable rate could dip below 6 percent and, well, how awful does that fixed bank loan, with its restrictions and prepayment penalties, look then?
So, what is the right play here? That might depend on how you read the current economy. Are we trending towards a recession? Double-digit interest rates? Or is our current state simply the aftershocks of our COVID-19 cash infusion, with interest rates stabilizing or even returning to previous variants as that shock subsides?
In the case above, the company has plenty of available cash. A potential $50,000 savings by flipping from the SBA loan to a fixed bank loan represents little more than a rounding error. Instead, consider making double payments and clear the loan in 3.5 instead of 7 years — something that banks penalize while the SBA encourages.
Do that, and the SBA loan, even at a higher rate, will end up costing less.
More importantly, as a new entrepreneur, you stay clear of those barbed-wire bank restrictions that might alter your original course and get you lost.
Ami Kassar is the founder and CEO of MultiFunding, a Philadelphia-based consulting firm that specializes in helping business owners across the U.S. develop creative, cost-saving alternatives for their business debt needs and structure. He can be reached by email at email@example.com or online at multifunding.com.