It's a good news-bad news situation for small businesses when interest rates rise.
The Federal Reserve says that the economy is doing well, so it has raised its key rates recently and is expected to do so again in the near future. The strong economy is great for most businesses, but higher rates will likely increase what it costs for them to borrow.
So what's a small business owner to do? Understand how the system operates and consider the ways they can manage.
Here are a few basics to help:
THE GOOD NEWS
Small businesses thrive when the economy is strong. Right now, the economy is doing quite well, which is why the Fed is comfortable raising rates. (One Fed official even referred to it as a 'Goldilocks' economy for being just right.)
The Federal Reserve doesn't directly control the rates a business might pay on a credit card, line of credit or loan directly, but these rates tend to move in the same direction as the Fed's benchmark rate. When the Fed raises its benchmark rate, it takes some time for that change to be reflected in the borrowing that businesses do.
Jared Hecht, co-founder and CEO of Fundera — a marketplace for small business loans — said he has yet to see rates for small business loans increase much, but he expects they will soon.
Hecht also said that while the cost of borrowing may go up with rate increases, it often becomes a more competitive marketplace for lending as the higher rate makes it more attractive for banks to manage loans.
The Fed last raised short-term rates in March to a range of 1.5 to 1.75 percent. Another quarter-point increase is expected in June.
THE BAD NEWS
Rising interest rates will likely increase costs for new small business loans, existing variable rate loans and credit cards.
The exact rate a business will pay depends on the type of borrowing and their credit profile. It is typically prime rate, which is at 4.75, plus a few percentage points based on how favorable the lender finds the borrower to be.
But any way you slice it, a higher interest rate means higher costs that will eat into cash flow and profitability. Plus, short-term loans to cover cash gaps, often needed by small businesses, may get more expensive or difficult to acquire, said Barry Coleman, who helped develop the small business counseling program at the National Foundation for Credit Counseling
While consumers may be feeling good in a strong economy and willing to pay for your goods and services, they eventually may feel pinched by rising rates and pull back on spending. Some businesses may also need to consider price increases to manage their increased expenses.
WHAT TO DO
Businesses have a few options in an environment of rising interest rates, experts say.
The simplest of those is to clean up your personal and business credit. Credit scores are a key factor for lenders when they decide whether to fund a small business. Make your payments on time, use credit only when absolutely necessary and keep your utilization low. The better the credit score, the better the rates.
The next is to think big picture about your strategic plans. If there are expansions or major investments you need to make, consider the timing in relation to rates and the economy.
"Because rates are still relatively low, small businesses haven't lost that opportunity to take advantage of low interest rates, especially as the economy is growing," Coleman said.
Coleman also noted that businesses have more options than ever on where to borrow, thanks in part to the growth of online financial firms. And big banks — those with assets over $10 billion — currently have a record 52.5 percent approval rate, Coleman said. That compares with small banks, which are considered the go-to for small business loans, at around 49 percent.
Additionally, if you have existing debt, try to form a relationship with your lender to help mitigate any bumps down the road, Hecht suggested.
Compare various products and various lenders to find the best fit as well. Hecht said business owners can often make a borrowing decision too hastily, when taking time to research before they commit could save them money.