When small business owners need funding, they often have two choices – fixed or variable rate loans.

These financing options each come with their own unique features and benefits.

Understanding these differences is key to making the best choice for your business.

So, when evaluating the options of a small business loan fixed or variable rate, which one should you choose?

In this article, we will explore the differences, the scenarios in which one is better than the other, and how to choose what’s best for your unique circumstances.

What are Fixed-Rate Small Business Loans?

Fixed-rate small business loans are a particular type of lending instrument where the interest rate, once set at the initiation of the loan, remains consistent for the entirety of the loan’s term.

From the moment you make your first repayment until your final installment, your interest rate remains static, and as a direct result, so does your monthly payment.

The initiation of a fixed-rate small business loan is uncomplicated. Upon your agreement to the loan, the lending institution offers you the key details – the principal sum (the amount you’ve chosen to borrow), the duration (the period within which you’ll settle the loan), and the rate of interest.

The interest rate is set following a comprehensive review of multiple elements, including the prevailing market conditions, your credit standing, and the lender’s specific guidelines.

One of the primary draws of a fixed rate business loan is its unwavering consistency. With a constant interest rate, your monthly installment remains the same.

This consistency lends itself well to straightforward budgeting, as you can confidently schedule your monthly outgoings without the concern of varying payments.

A further benefit of fixed-rate loans is their ability to protect you against unforeseen spikes in interest rates. Should the overall market rates climb, your loan’s interest will stand firm, offering you a layer of protection and potentially saving your business a considerable sum in a period of increasing rates.

However, it’s essential to acknowledge that this protection carries a certain price. Fixed-rate loans generally kick off with interest rates that are higher than those of variable rate business loans. Lenders incorporate this extra cost to counterbalance the potential risk of rate increases over the lifespan of the loan.

Consider a small business securing a $50,000 fixed-rate loan with an interest rate of 6% for a five-year term.

The business will repay the loan in equal monthly installments throughout the specified term, with the interest rate holding steady at 6%, impervious to market variations.

Consequently, the business can structure its budget with assurance, safe in the knowledge that its financial commitment remains constant.

Nevertheless, should the market rates undergo a significant decrease, the business wouldn’t gain any advantage from these lower rates.

The decision between a fixed and variable rate ultimately boils down to balancing stability against potential savings. In light of this, the question “is fixed or variable rate better” doesn’t have a one-size-fits-all answer, but depends on the specific needs and conditions of each business.

What are Variable-Rate Small Business Loans?

When choosing between a small business loan fixed or variable rate, it’s important to understand how each type works. Variable-rate small business loans, unlike their fixed-rate counterparts, have interest rates that can adjust over the lifespan of the loan. These rates are typically linked to a benchmark rate like the prime rate or London Interbank Offered Rate (LIBOR),

In a variable-rate loan, your interest rate would start with the lender adding a margin to the benchmark rate. But as the benchmark rate fluctuates with economic conditions, so too will your loan’s interest rate, and in turn, your monthly payments.

While variable-rate loans can offer lower initial interest rates than fixed-rate loans, they also carry the risk of increasing payment amounts if the benchmark rate rises. This type of loan requires a degree of financial flexibility, making it suitable for businesses comfortable with some degree of unpredictability in their financial planning.

Imagine a small business takes a $50,000 variable-rate loan with an initial interest rate of 4% for a period of 5 years. If the benchmark rate rises, the interest rate on the loan might increase to 5% or 6%. Consequently, the business’s monthly payments will go up. However, if the benchmark rate falls, so too will the interest rate and monthly payments.

Difference between Fixed-Rate and Variable-Rate Loans

Fixed-rate loans offer stability and predictability, while variable-rate loans offer the possibility of lower interest costs, but with the risk of rates increasing. It’s like choosing between a well-known path and one that could lead to unexpected destinations.

Are Variable-Rate loans lower than Fixed-Rate Loans?

Initially, variable-rate loans often come with lower interest rates than fixed-rate loans. However, it’s important to remember that these rates can rise, potentially surpassing the rate you might have locked in with a fixed-rate loan.

Is Fixed or Variable-Rate Better for Your Small Business?

The choice between a fixed and variable-rate loan isn’t one-size-fits-all. It’s a decision that must be carefully tailored to your business’s individual circumstances and financial health. Let’s delve deeper:

Loan Length

The duration of your loan can significantly impact whether a fixed or variable rate is preferable. For short-term loans, a variable rate might be more cost-effective, particularly if market rates remain stable or decrease.

However, for long-term loans, the safety of a fixed rate, ensuring predictable payments, could be more appealing, effectively shielding you from potential rate hikes.

Risk Tolerance

Your business’s comfort level with financial risk is a key determinant in the fixed versus variable decision.

Are you prepared to weather the possibility of rising payments, taking that risk in exchange for the potential to save on interest costs if rates fall?

If the thought of fluctuating payments keeps you up at night, a fixed-rate loan may be your best bet.

Interest Rate Fluctuations

Keeping an eye on the economic horizon is critical.

Anticipating future market trends and understanding the likely direction of interest rate changes can impact your decision.

If rates are forecasted to rise, a fixed-rate loan, which locks in your interest rate, could be a safer choice.

Business Revenue Stability

Does your business have a steady stream of income, or are there peaks and valleys?

Businesses with stable revenue may be better equipped to handle the potential payment fluctuations of a variable-rate loan.

However, for businesses with less predictable income, the stability of a fixed-rate loan, providing consistent monthly payments, may be a more suitable option.

Company Size

The size of your company plays a role as well.

Larger companies might have more of a financial buffer to cope with changing interest rates, while smaller businesses, particularly those on a tight budget, may prefer the certainty of fixed payments.

Balancing your company’s size and financial flexibility against the potential risks and rewards of each loan type is essential.

Can you Switch from Variable to Fixed-Rate Loan?

Yes, it’s possible to switch from a variable to a fixed-rate loan through the process of refinancing.
Refinancing is essentially the process of taking out a new small business loan fixed or variable to pay off your existing loan, allowing you to change the terms to better suit your current financial situation. However, it’s critical to understand that refinancing may come with additional costs, such as fees or penalties for early repayment of your original loan.

Also, the interest rate of the new loan could be higher depending on market conditions at the time of refinancing. Hence, it’s essential to conduct a thorough financial analysis and consultation with your lender or financial advisor before making such decisions.

What Questions Should You Ask Your Lender?

When considering a small business loan, either fixed or variable, it’s important to get all the information you need from your lender. Here are some key questions to ask:

• How often does the interest rate adjust on a variable rate loan? This question is crucial as it affects your monthly payments, and ultimately, your budget.
• Is there a cap on how much the interest rate can increase on a variable rate loan? This gives you a sense of the maximum possible payment you may have to make.
• What fees are associated with each loan type? Understanding fees associated with your loan allows you to calculate the real cost of the loan.
• What are the implications of these fees on my overall repayment? This helps in planning your business finances better.
• Is it possible to switch from a variable to a fixed-rate loan in the future? If so, under what conditions? Knowing your options for future adjustments gives you flexibility.

Getting clear answers to these questions is key to making a fully informed decision about the best loan for your small business.

Get a Small Business Loan from Equire

Ready to secure the right small business loan?

Trust in Equire’s expertise.

With a deep understanding of fixed and variable rate loans, we tailor our approach to your unique financial needs, serving as your trusted advisor in this pivotal decision.

Whether you’re attracted to the predictability of a fixed-rate loan or the potential cost savings of a variable-rate loan, we guide you through each step of the process, ensuring you factor every available option into your decision. Our commitment extends beyond just recommendations – we aim to provide professional guidance based on our expertise in the field, and to provide clear and detailed answers to your questions.

From how often the interest rate adjusts on a variable rate loan, to the potential fees associated with each loan type, we’ll ensure you feel confident and well-informed before making a decision.

Your financial goals are our priority, and we are dedicated to offering top-notch service, whether it’s aiding in obtaining a collateral business loan, starting a business, or consolidating existing debts.

Don’t navigate this journey alone, partner with Equire today – your success is our success.