July 30, 2022
Reading time: 3 mins
Last Wednesday, the Federal Reserve decided to raise its benchmark interest rate by 0.75%, making it two consecutive months of interest rate hikes by the central bank. If all goes well, the rate hikes should lower inflation and bring costs down for small businesses.
Although inflation still matters (read this to learn why), interest rate hikes will probably become an urgent issue facing small businesses in the coming months. If you want to get ahead of the competition and understand how recent Federal Reserve decisions affect your business, keep reading.
How does the Federal Reserve raise interest rates? What does that mean?
Let’s start by explaining what it doesn’t mean: the Federal Reserve does not go around telling banks and other financial institutions what interest rates they should charge on business loans or what yields they should offer on business savings accounts.
Instead, the Federal Reserve tries to influence interest rates across the economy through a single interest rate: the Federal Funds Rate (FFR). The FFR is the rate banks charge each other for overnight loans, and it’s important because banks and other financial institutions use it as a basis for pricing loans to consumers and businesses, particularly short-term loans and credit. As such, when Fed policymakers raise the FFR, it eventually filters through to your business savings accounts, credit card rates, loans, etc.
How does the Federal Reserve rate hike affect small businesses?
1. Borrowing costs rise
Interest payments on existing, fixed-rate loans will not change. However, payments on business lines of credit and other variable-rate loans will increase with each additional rate hike.
Since we don’t know how many rate hikes are on the horizon, your day-to-day cash flows might get more volatile. Purchase bookkeeping software to track your expenses, and consider postponing any investments until interest rates have stabilized. For now, hold on to cash and make sure you can service your debts. Nothing will hurt your ability to get a loan in the future more than failing to make an interest payment now.
Alternatively, consider refinancing to a fixed rate loan. Even though rates are higher now, keeping your cost of debt stable allows you to plan expenses more easily and protects you from future rate hikes. If you’re thinking about taking out a loan, now is the time - interest rates are expected to rise above where they are now.
That said, keep in mind that locking in a rate now means you have to pay that rate even if interest rates come down in the future.
2. Short term credit/credit cards become more expensive
As mentioned earlier, banks use the FFR as a starting point for calculating the rates they charge on business credit cards and loans. Credit card rates will have higher APRs, which means larger monthly payments for business owners with outstanding credit card balances.
Paying down your credit card debt is probably the best course of action. Although a 0.75% increase may not seem significant initially, there may be more rate hikes to come. Credit cards tend to have high interest rates, so any additional hikes can make your outstanding balance grow even faster and make paying down the debt even more difficult in the long run.
3. Business growth stalls
When interest rates go up, the average person pays more money each month on their credit card, car loan, student loan, and mortgage. With more of their budget going to debt payments, customers may stop buying your items or services as frequently as they have in the past.
Depending on your sector and the customers you serve, your services or products could be the first things consumers cut from their budget. (Businesses selling big-ticket items that require financing may suffer the most as shoppers also face higher borrowing costs). As a result, your business's customer retention and acquisition rates will drop, lowering your revenues.
What can small business owners do to get lower interest rates?
Interest rates vary according to risk. The more risky a loan is, the higher the interest rate the bank needs to compensate for that risk. As we explained here, when lenders can trust information they have about your business, lending risk goes down and the chances of you getting a low interest loan go up.
You know your business better than anyone - reach out to email@example.com and tell us about it. We’ll share that information with financial providers and make sure you get the best loan for your business.