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Small-Business Loans: Fixed vs. Floating Rate

Comparing Popular Loan Options for Small Businesses

Interest rate percentage increaseDifferent businesses have different funding needs, and as a result, most banks offer a range of lending options for them to choose from. Two of the most common small-business loans involve either fixed or floating rates.

What is the difference between these two types of loans and how can you choose the one that is right for your small business? Here, we compare the two rates across a number of different business needs so you can make a more informed borrowing decision.

Cash Flow Needs

Some businesses require a lot of money in order to become established. These businesses tend to require large amounts of cash in order to meet initial startup costs, which can include equipment purchases, inventory purchases, franchise licenses, and other expenses. For these companies, a small-business loan with a floating rate may allow them to have lower initial payments during a time when they need the additional cash flow.

Meanwhile, for companies that do not require a lot of startup funds, a fixed rate may make better sense, because it has a set monthly payment that is not affected by the changes in the rising interest rate environment. Plus, the payment can be easily included into the budget because the amount is fixed. Fixed rate loans are better suited for companies with consistent needs for marketing and payroll expenses.

Interest Rate Trends

As of the time of this writing, interest rates are very low, but as history shows, rates can change in a moment’s notice. Choosing a small-business loan with a fixed rate while the national interest rate is low will allow your business to avoid future interest rate increases.

Or, if at the time of reading, interest rates have increased substantially, then an entrepreneur should wait until the Fed stops raising interest rates for three quarters and then apply for a floating rate loan. This will help the borrower to take advantage of the eventual decline in the interest rate that the trend is predicting.

Time Horizon

If history is any guideline, tradition tells us that a borrower is more likely to pay less interest overall with a floating rate loan versus a fixed rate loan. However, this does not automatically mean that the floating rate should be chosen because the borrower must also consider the amortization period of a loan. The longer the amortization period, the greater the impact will be in the changes in the loan’s interest rates and the amount of one’s payments.

Dave Donovan

Author:

Dave Donovan has written extensively for the web with a primary focus on articles targeting finance and business.