The success of any small business is dependent on internal factors specific to the business as well as external factors related to the economy and the market the small business operates in. The overall economic environment is one of these external factors, which is in part impacted by the rise and fall of interest rates. Low interest rates have the power to spur consumer spending and make taking out low-cost loans accessible. This can be rather a beneficial situation for small business owners, as they extract double benefit: an economy energized with purchasing power from customers with more disposable income, and cheap debt capital to support the higher business activity.
To better understand how low interest rates affect small businesses—and how to make the most of them—we’ll delve into what these rates actually mean, their direct impact on businesses, and what happens if interest rates start rising.
- The Federal Reserve plays a key role in raising or lowering interest rates depending on the current economic conditions in the country.
- Small businesses benefit from a low interest rate as it reduces the cost of debt and encourages more customer spending.
- Businesses should prepare for increased interest rates by investing in assets and paying off debt during times of low interest rates.
What Do Low Interest Rates Mean?
An interest rate is an amount a borrower is charged by a lender for access to capital, and the Federal Reserve (Fed) affects the interest rate by setting the federal funds rate. This is the interest rate a bank pays another bank for a short-term loan.
The Fed plays a primary role in raising or lowering the interest rates, depending upon the current economic standing of the country. Changing the interest rates impacts employment rates and prices while also creating a regulatory system for interest rates.
Interest rates are lowered during times of recession or economic downturn to energize the economy. Lower interest rates across items such as mortgages, car payments, and loans make it easier for consumers to borrow funds and, in turn, correlate to more spending power.
But high or low interest rates affect businesses just as they do consumers purchasing their products or services. When the Federal Reserve makes the decision to change the interest rate, the entire economy is impacted. Both suppliers and buyers must remain aware of how to address the effects of low interest rates.
How Low Interest Rates Affect Small Businesses
When the Federal Reserve lowers interest rates, it means current economic conditions are lagging and in need of stability. Small businesses are a crucial part of the economy and find themselves impacted in many ways by lower rates. This includes a reduced cost of debt, higher customer volume, and more difficulty obtaining loans.
Reduce Cost of Debt
A small business can optimize for growth and expansion during a time of low interest rates. When borrowing costs are lowered, it can help small businesses pay off debt or take out new loans at a lower rate, which can lead to a more positive impact on their bottom line. The money businesses are saving from a lowered cost in borrowing can be invested back into the business to fund new product development, market more widely, or cover a new hire’s salary.
During a period of low interest rates, instead of putting money into an interest-bearing account as a form of long-term business investment, consider spending the money on new assets, such as equipment or land, that will boost production for your business.
Higher Customer Volume
The Fed lowers interest rates to energize the economy with more spending power, creating more disposable income for the average consumer. But this is a benefit that also positively impacts small businesses.
Consumers are increasingly purchasing goods and services from businesses as they have excess balances to spend. Small businesses may find customer volume and purchase sizes drastically increase during economic conditions that spur low interest rates. The money that would often go to paying off costly debt in mortgages and the like can now go to purchasing a small business’s products.
More Creditworthiness for New Loans
Though many positive impacts come from a lower interest rate, there are some setbacks to note from a small business perspective. Most importantly, business owners should be aware of the increased difficulty to obtain a loan during this time.
Since banks profit heavily from lending money to consumers and businesses, they typically tend to prefer a higher interest rate as their net margins can be impacted if rates stay low for long. As such, banks want to focus on higher-yielding assets with more reward and less risk and may see your small business as too risky to loan to.
A low interest rate on a loan can be a catch-22 scenario for a small business. Taking out a loan leaves you with the ability to cover the cost of expansion and not spend so much on debt, but banks may be unwilling to fund a loan.
Being savvy during this time and reinvesting money into the business from higher sales or paying off larger amounts of debt can help you make the most of a low interest rate.
What Happens When Interest Rates Start Rising?
Low interest rates should signal to small businesses it’s time to welcome more customers, create more products, and invest in new assets. There are many ways to make the most out of the opportunity, but business owners should ensure they are prepared for the inevitable rise in interest rates.
An increase in federal fund rates means loans are more expensive to borrow and can take longer to pay back. Further, consumers have less to spend, which decreases sales and makes it harder for small businesses to reinvest profits and expand operations.
The Fed typically raises interest rates to temper a period of high inflation. During this time, taking out a loan or mortgage comes at a much greater cost, leading many to hold onto their money as opposed to spending it.
Small businesses can be ready for higher interest rates by:
- Paying off more debt during a period of low interest rates in order to avoid spending more with a higher interest rate
- Preparing to open a higher-yield savings account with additional profits made from a low interest rate time period
- Building a reliable customer network who trusts the products enough to return even with less spending money available to them
By thinking ahead, a small business can make the most of a lower interest rate period in order to smoothly transition to a time of higher rates. Some blowback from increased rates is inevitable, but a small business should build a plan for continuing growth and innovation even during that time.
How Long Will Interest Rates Stay Low?
The current economic standing dictates whether the Federal Reserve increases or decreases interest rates. Interest rates can remain low for extended time periods if the Fed decides that is necessary to re-energize the economy. Staying aware of the Fed’s forecasting of economic performance can help small business owners understand when the central bank may introduce an increased interest rate.
Who Benefits the Most From Low Interest Rates?
Both consumers and small businesses alike can benefit from low interest rates. Consumers have more disposable income to spend on necessities and desires while small businesses profit from this increased level of sales.
Banks may benefit the least during times of low interest rates as they don’t make as much profit from the payment of interest rates on loans.
What Should a Business Do With Cash When Interest Rates Are Low?
Interest-bearing accounts won’t have the same financial impact when interest rates are low. Rather, small businesses should use cash to invest in new assets, such as materials or equipment, or pay off current loans.