Fed Confidence in the Economy
For starters, let’s consider why the Fed raised the rate in the first place: confidence in the U.S. economy. The central bank, following its mandate to foster maximum employment, stable prices and moderate long-term interest rates, determined that the economy has gained enough momentum to flourish despite a modest interest rate increase. After all, household spending is up, and the latest U.S. Bureau of Labor Statistics jobs report indicated a steady pace of employment, with 211,000 new hires in November and 5.0 percent unemployment (half the peak unemployment of 10.0 percent in October 2009).
Meanwhile, U.S. small business activity is on the rise in almost all 50 states. Entrepreneurs are poised to reap the benefits of the stronger consumer base that comes with improved employment, but the rate hike will increase the cost of capital for those seeking traditional financing in 2016. While the Fed fund rate doesn’t directly affect business loans, banks use that rate to set their own prime rates, which will impact small business loans.
The Bad News for Traditional Small Business Lending
Payments will increase — modestly — on existing loans with floating interest rates, such as most Small Business Administration (SBA) loans, unsecured lines of credit, business credit cards and peer-to-peer lending. This additional expense could undercut cash flow and profitability for some, and the cost of credit will also rise compared to previous years.
However, the change isn’t as dire as it may sound. Yes, every penny counts to small businesses, but an increase of 0.25 percent probably won’t force owners to shutter their businesses. But what if the Fed raises the rate further in 2016? While experts disagree on the amount that rates might rise next year, the Fed probably won’t rush to increase them. Wary of choking off the country’s slow recovery from the Great Recession, the Fed has consistently advocated a slow, cautious approach to monetary policy.
Even in a scenario of a 1 percent increase over the course of a year, how much would that change the cost of capital? The SBA lenders we work with at Guidant aren’t anticipating an increase in any other fees, so the change in cost should come from interest rate alone. According to TD Bank’s online calculator, if you have a $250,000 SBA loan amortized for 120 months that jumps from 6.0 percent to 7.0 percent. Your monthly payment of $2,787 would increase by $129 to $2,916 for an annual increase of $1,548. It could be wise for business owners to build at least a 0.25 percent increase into their budget assumptions for January and July to prepare for a modest increase in the cost of capital.
How to Take Advantage of the Upswing
The Fed rate increase will likely encourage a lot of savvy entrepreneurs to make the most of current rates while the economy’s on an upswing and before rates can jump significantly. Sure, financing might cost more than last year, but those that are disciplined enough to take their loan to multiple sources may have enough leverage to lock in fixed rates near historical lows. An SBA packaging firm may be helpful in this regard. Also, adjustable-rate financing will remain a bargain for the foreseeable future. Meanwhile, businesses won’t see any increases in their existing fixed-rate loan payments.
Even business owners nervous about interest rate hikes can capitalize on warming economic conditions by pursuing funding options that don’t depend on interest rates, such as Rollovers as Business Start-ups(ROBS). Rather than borrowing, entrepreneurs can invest funds from their existing retirement plan into a small business or franchise without incurring a tax penalty. Since it’s not a loan, ROBS will never be affected by interest rate hikes.
More Available Financing
I also anticipate greater availability of small business financing. Average FICO scores are trending upward. Potential borrowers who declared bankruptcy or defaulted on mortgages when the economy was at its worst are seeing those big derogatory marks drop off their credit reports, and lenders are demonstrating greater flexibility to applicants who have been working to improve their credit.
How Consumers Will Be Affected
Consumers won’t be unaffected by higher interest rates, since consumer debt has been rising. However, the rosier employment situation will help cushion the impact. Better rates benefit savers, but consumers probably won’t be tying up all their cash into CDs or savings accounts in droves. Why? Even if they receive larger returns on cash savings relative to the past seven years, inflation still remains below two percent, so saving doesn’t increase their buying power — they might as well spend, which is more good news for business.
Now, I’m not claiming that the U.S. has completely shaken off its economic woes. A sizable “jobs gap” of 2.8 million jobs persists between current employment and pre-recession levels, and both consumer confidence and small business optimism remain shaky. Still, entrepreneurs have a window of opportunity before rates rise significantly to secure reasonable financing that can help them launch or expand at a crucial turn in the economy and give them plenty of reason to celebrate in 2016.
– David Nilssen, CEO & Co-founder, Guidant Financial