After keeping the interest rate unchanged at near-zero — where it has been set since March 2020 — the Federal Reserve has signaled that it will end its easy-money policies in March 2022. The Fed has already slowed the bond-buying program that it had been using to bolster the U.S. economy, and that program remains on track to conclude next month.
Most recently, at the January 2022 Federal Open Market Committee meeting, the Fed said that it would keep its target for the fed funds rate at a range of 0.0% to 0.25% in order to contain soaring inflation, the worst in 40 years, which is continually threatening the economy.
What happens when the Fed raises interest rates?
When the Fed raises its benchmark rate, the federal funds target rate, it reduces the availability of money and increases the cost of credit throughout the economy.
An uptick in interest rates makes loans more expensive for both businesses and consumers, as everyone in the economy ends up spending more on interest payments. And those who can’t or don’t want to afford the higher payments opt to delay their projects that involve financing.
At the same time, it makes savings attractive for people who tend to save more to earn higher interest payments. All this in tandem reduces the supply of money in circulation, which tends to lower inflation and moderate economic activity and in turn cool off the economy.
What do rising interest rates mean for your business?
Although the impact of rising interest rates varies by business, it’s mostly not good. Here’s how rising interest rates can impact your business:
It will impact the ability to grow
. Rising interest rates translate to higher loan payments. This is likely to lead to a reduction in profitability, which in turn can make securing future funding more difficult. Without these loans, you may be forced to reallocate business resources of your business away from innovation and reinvestment. Additionally, you may have to put off investment and expansion plans, which can further slow the growth of your company.
It will reduce cash flow.
Small businesses tend to operate with limited cash flow, so when interest rates rise, cash flow contracts and additional cash needed to repay other loans is likely to be scarce. This can make it difficult to cover daily expenses and create additional financial hurdles over time, such as making it unaffordable or harder to qualify for short-term loans to cover any cash flow gaps.
It will affect customers’ spending habits.
Changing customer spending habits triggered by climbing interest rates could also shrink your cash flow. With consumers having to pay higher interest on their loans, such as mortgages and auto loans, they will have less disposable income to buy goods and services. Hence businesses, particularly consumer-driven ones, are likely to see a reduction in sales, further squeezing cash flow. Higher interest rates also make it more attractive for consumers, as well as businesses, to save extra cash rather than spend it.
Given the above, doesn’t it make sense to make sure you’re ready?
How to prepare for rising interest rates
Here are four money moves that you can consider to navigate your business through the forthcoming environment of rising interest rates.
Switch to a fixed rate.
Once the new interest rates become effective, banks will begin charging more for business loans. While this may not affect businesses with fixed-rate loans immediately, those with loans that have fluctuating interest rates — one that adjusts over time in response to changes in the market — are likely to find their burden swelled when their loan rate resets.
If your existing business loan is at a variable rate, convert it to a fixed-rate one that will protect your business against changes to the federal funds target rate.
Start budgeting for higher payments.
As interest rates go up, so too will the size of your payments — meaning you will be responsible for apportioning a larger payment every month. Be vigilant about the rate adjustment period in your existing loan, and make sure you are prepared for the increased payment without disrupting your cash flow.
Start exploring other financing options.
Considering that traditional business loans are getting a bad rap with the anticipated interest rate hike, now is the time to scout around for alternative financing solutions.
For instance, lending options such as invoice factoring can be a viable option for your business to access cash, considering it does not require you to take on debt. Further, there’s the business line of credit, which allows you to pull out funds from the account and pay them back with interest. Opting for a credit line from your lender can be a cost-effective solution if you are not in urgent need of financing but only require enough funds for an equipment repair or other emergencies.
If you’re planning to get a small business loan, do it sooner.
While you might not feel the impact of the interest rate hike now, you will feel the pinch of costlier business loans if this trend continues over the next couple of years. It’s a crucial reason to consider applying for a business loan now rather than later.
