How rising interest rates affect your business - and what to do about it

Interest rates in the United States have stood at record-low levels since the onset of the pandemic-but that's about to change. The Federal Reserve, the bank that dictates the rate of lending, plans to raise interest rates to deal with high inflation. The first interest rate hike could happen as soon as March 2022, according to experts, with multiple potential hikes planned after that. 

Whether you're currently paying off a business loan or looking to apply for a loan, it's important to understand how these increased interest rates could impact your plans.

4 ways higher interest rates affect your business

Changes to the economy have a ripple effect. Fluctuating interest rates influence how your business operates, how much revenue or sales you bring in, and how loyal and consistent your customers are. Here's how: 

1. Increased interest rates can limit your cash flow

Rising interest rates make your business debt more expensive, which means you'll have to use more cash to cover your interest costs. Depending on your business's overall financial health and profit margins, you might have less flexibility to invest in long-term growth-or less day-to-day cash flow stability.  

2. Rising interest rates can prevent you from getting short-term credit

When interest rates go up, not only do long-term loans become more of a burden, short-term loans also become less accessible. The first hurdle is qualifying. When short-term financing solutions-like business lines of credit or business credit cards-have higher interest rates, you may need even higher credit scores to get approved.

The second hurdle is repayment. Even if you do get approved for a short-term loan, the interest rate may be too high to manage, setting you deeper into debt. If you can't afford to take on short-term debt to bridge a cash flow gap or deal with an emergency, your business might struggle to get ahead. 

3. Increased interest rates curb consumer spending 

When interest rates rise, the average person has to shell out more money to make the minimum payments on their student loans, car loans, and mortgages. When finances are tight, people stop spending as freely and start eliminating certain purchases. Depending on your business's industry and customer base, your particular services or products could be the first expenses consumers cut from their lives. As a result, your customer retention or acquisition rates could drop, lowering your overall revenue and sales. 

4. Higher interest rates make it tricky to plan

Your business finances are the foundation of your operation, so it's crucial to have a solid grasp on your business's expenses, cash flow, and profits. Changing interest rates, however, can confuse even the most straightforward of finances. With interest rates in flux, you may have a harder time updating your financial plan and preparing for growth, especially if you already have a variable-rate loan. 

Should you get a business loan now? 

If you're considering applying for a business loan before federal interest rates increase, it's crucial to make sure you're doing it for the right reasons. A business loan can help you stabilize or expand your operation-but only if you're in a decent financial position. 

Here are a handful of reasons to apply for a business loan soon before interest rates spike: 

1. To lock in a lower interest rate: If you apply for a fixed-rate loan now, your interest rate will stay the same for the duration of your loan starting at the point that you receive funding. Not only will you be able to take advantage of the current low interest rates, you'll also save money and set yourself up for more predictable budgeting. 
2. To invest in a growth project: Maybe you want to purchase real estate or develop a new product. If your finances are stable and you need extra capital to take advantage of an exciting opportunity, a loan could help. 
3. To cover upfront costs: A loan can give you the cash you need to satisfy customer demand. You may want to stock up on inventory ahead of a busy period, set your seasonal operation up for success, or purchase new equipment. 
4. To refinance existing business debt: Refinancing a current business loan could help you score a lower interest rate and pad your cash flow. 

Before you decide to apply for a loan, take some time to consider your funding needs, business goals, and financials. Ultimately, you want a loan that will support your operation, not drag you down. That's why it's a good idea to hold off on getting a business loan if:

• You already have a high debt service coverage ratio (DSCR). Here's how to calculate your DSCR. 
• You're not bringing in enough revenue or sales to justify the cost of debt. 
• Your industry or market is on a downward trend. 
• You want to make a big purchase, but don't have a realistic plan to pay it off. 

Types of business loans to consider

If you're eager to lock in a low interest rate or invest in your business's growth, here are several different financing options to consider: 

• Business line of credit: A business line of credit is a good option for ongoing cash flow maintenance or short-term needs, like buying inventory for a busy season. 
• Term loan: A long-term business loan can give you sizable capital for major investments and more affordable interest rates compared to short-term financing options. Plus, depending on the lender you choose, you may be able to get a fixed-rate loan and make payments on a predictable monthly basis.
• Equipment financing: Equipment financing is helpful when you need to buy expensive machinery or technology to either support your business's operations or give you a competitive edge. 
• Small Business Administration (SBA) loans: Loans backed by the SBA generally have more affordable interest rates and longer borrowing periods. They're good options for businesses with solid financials and strong credit scores.