Fixed vs. Variable Rate Term Loan Business: What You Need to Know

There are a lot of loan options for business owners, which can also be overwhelming for them. However, selecting the right one for your business can give you a feel of a financial maze, especially when you need to decide between fixed rates and variables.

If you are looking to manage your cash flow, expanding business, or investing in new business equipment, the type of term loan business you select can significantly impact the financial health of your business and its growth potential.

In this article, we will discuss the critical distinction between fixed-rate and variable-rate options. You will be able to make an informed decision by the end of this article to select which loan option will be best for you.

Understanding variable-rate loans

Variable rate loans are a type of term loan business where the interest rate changes with time. They are tied with a prime rate, which is often set by the Federal Reserve. Therefore, the interest rate keeps on changing according to the change in market conditions.

Here’s how variable-rate loans operate: Your loan agreement will outline a set margin above a benchmark rate. For instance, if the prime rate is 3% and your margin is 2%, your interest rate would total 5%. When the Federal Reserve changes the prime rate, you interest rate adjust accordingly, reflecting the new benchmark.

The monetary policy of the Fed plays a crucial role along with the overall economic condition and market rates. The rates usually rise during the economic growth season and fall during downturns. It’s essential to note that this term loan business is not for any single loan type. There are multiple types, and they have their own terms and conditions.

Understanding fixed-rate loans

When it comes to fixed-rate loans, you don’t have to put a lot of your mind into them, as the interest rate remains constant for the entire loan life. It won’t matter if you are borrowing the loan for five years or more; it won’t budge, irrespective of what’s going on in the broader economy, making it the hallmark of this term loan business.

In this case, since your monthly payment remains the same throughout the loan term, it will be easier for you to make budget plans for your business. Fixed variable works on the terms of the lender, as they calculate your payment based on the loan term, principal, and interest rate. The amount is further divided into monthly payments for the entire term.

It’s important for you to note that since your payments remain the same, the interest to the principal fluctuates over time.

Comparing the two

When you need to choose between the two-term loan business, you need to consider the following factors,

Risk

Variable rates have a greater risk as per the potential rate increase as compared to fixed rates, where the payments are predictable.

Cost

Variable rates may have low initial costs with uncertain long-term expenses, as compared to fixed rates with high initial rates but predictable total interest rates.

Loan amount

Variable rates can let you borrow large loan amounts, but fixed rates may offer you conservative loan amounts.

Repayment terms

Variable rates are more flexible with short-term than long terms with consistent payments at a fixed rate.

Credit score considerations

Variable rates can be accessible but riskier for those who have bad credit. But at a fixed rate, you get a lot of options if your credit score is good.

Considerable factors

When you are seeking term loan business as a small business owner there are few factors that can influence your decision like,

Business Goals: Are you financing immediate operations or aiming for long-term growth? Short-term needs may be better suited to variable rates, while fixed rates often support long-term stability.

Business Plan: How does this loan fit within your broader business strategy? Make sure your financing aligns well with your overall goals.

Financial Stability: How well can your business manage potential fluctuations in payments? A fixed rate could offer a safer choice if cash flow is unpredictable.

Market Outlook: What are your expectations for interest rates? A variable rate could provide savings if you anticipate a decline in rates.

Creditworthiness: Both personal and business credit scores impact the rates available to you. Higher scores typically unlock more options and better rates.

Risk Tolerance: How much uncertainty can your business budget withstand? Choosing a variable rate requires a higher tolerance for risk.

Conclusion

Choosing between a fixed-rate and a variable-rate loan depends on your business goals, financial stability, and risk tolerance. Fixed-rate loans provide stability, making them ideal for long-term growth plans where predictable payments are crucial.

Variable-rate loans, however, can be beneficial for short-term needs or if you expect interest rates to drop, but they require a higher risk tolerance due to potential fluctuations.

By carefully considering factors like your credit score, market outlook, and repayment preferences, you can select the term loan business type that aligns with your financial strategy and supports your business’s growth and stability.