Recently, the Federal Open Market Committee boosted interest rates by 75 basis points. The decision could have a huge impact on those applying for small business loans.
Chris Hurn, Founder and CEO of Fountainhead Commercial Capital, returns to the program to talk about what this could signify for small business lending.
Check out the edited transcript of this latest episode of Small Biz in :15. Watch the full show above and check out our SoundCloud player below to listen there.
Small Business Loans Interest Rates Change
Shawn Hessinger: Let me start by asking what has changed with small business loan interest rates in the last couple of weeks and why?
Chris Hurn: The Federal Reserve increased their overnight rates again by 75 basis points. So, it’s gone up considerably since even six months ago. And the reason that’s important is that they are the pacesetters for all the other indexes out there that determine interest rates, whether consumer, business or otherwise.
So, everything sort of falls in line with what the Fed does. For instance, we’ve seen Treasury yields go up…we’ve seen SOFR, which is now the new LIBOR interest rate index…a lot of business loans are priced off that. And obviously, The Wall Street Journal prime indexes also fall in line and increase just exactly when the Fed Reserve increases. And all of this means that borrowing costs are rising considerably.
Shawn Hessinger: How does this affect small business lending specifically?
Chris Hurn: Well, most small business lending, or at least Small Business Administration lending, is based on Prime. And so Prime has gone from three and a quarter to six in a quarter in about six months already this year. So that’s a 300-basis point movement–3% has been added to the borrowing costs of a typical SBA loan.
So, it’s moved up considerably and almost doubled in that timeframe. And while most business owners can probably handle that a little bit, particularly because you’ve also had this ripple effect of inflation of business owners increasing their prices for their products and services, the issue is going to be a delicate balance.
And the higher interest rates go, the more likelihood there is for defaults, which really causes trouble to the small business owner in terms of being able to meet their monthly debt obligations.
Don’t Wait to Look at Your Financing Options
Shawn Hessinger: For anyone watching the show, what would be your main piece of advice?
Chris Hurn: The biggest thing I always say to small business owners is to not wait to look at this when it’s too late. There are a lot of different financing options out there for the typical small business owner.
Not everybody has a bank loan, not everybody has an SBA loan. Some people factor the receivables, some people have rigid cash advances, some people have hard money loans, but anything that’s sort of above conventional pricing–so any of those latter three ought to be things that a typical small business owner looks at refinancing now…even though rates are going up, you’re going to feel it much more so with those higher-priced options.
So, if you can take a look at refinancing your interest rates, you know it’s going to be higher perhaps than some of them. But you also probably will be able to lower your effective borrowing costs. And you’ll be re-amortizing the debt as well, which means that your monthly payment should go down. And that’s something that will really help the monthly cash flow for a typical small business owner.
The other thing I would tell you, Shawn, is that times like these are when a lot of the conventional lending options sort of go to the sidelines; the banks, the credit unions, they get very nervous when the economy is slowing down, which is clearly what the Fed is trying to do here– because in slowing down the economy, it will reduce inflation.
Shawn Hessinger: How do interest rates directly relate to small business lending? How does that affect what kind of loan you get? What kind of loan should you be looking for that sort of impact?
Chris Hurn: It mostly affects it directly in terms of the pricing. Every business loan is going to typically be priced on an interest rate index, such as Prime or SOFR or, you know, five-year Treasury yields or something like that, plus a spread.
And that’s how you get to the effective interest rates that the borrower is paying. So, as you can tell, any time you’re increasing the indexes, even if you’re not changing the spread over those indices, you’re going to have higher borrowing costs.
Shawn Hessinger: Do you expect the increase in interest rates to have a major impact on the number of small business loans approved or the number that is even applied for?
Chris Hurn: I don’t think there is a diminishment in demand yet. Obviously, there will be if the Fed continues to march forward on this aggressive increase in a rate hike pace. But I don’t think we’re quite there yet.
And even in slower economic growth times, you always have demand for some borrowing from the business community, frankly, where we’re an economy. You know, the whole globe is built off credit. So that’s not going away any time soon. But the sources for that credit are what’s going to change.
So, the number of businesses that can get approved for a loan from traditional sources will shrink because a lot of those folks I was talking about before, the traditional lenders, like banks and credit unions, tend to tighten up what they will or won’t approve during times like these. And so that’s also why some of these business owners end up being diverted to SBA lenders like us because we still tend to be pretty aggressive during these times.
You know, SBA provides a government guarantee or think of it like insurance on the commercial loans that we make. Therefore, we have a broader credit box of what we can approve or not approve. And again, this is I’m making some generalizations here because the truth of the matter is some of the most active SBA lenders are banks and they happen to have an SBA department.
But as a non-bank SBA lender, there’re relatively few of us. We tend to operate based on the SBA’s intention. So we’re not making traditional conventional commercial loans. We don’t have anything but our SBA credit policy to give us our guidelines on what credits to approve or not. You’re going to see movement toward SBA lenders, for sure.
Advantages of SBA-Backed Loans
Shawn Hessinger: Maybe we should explain again when we talk about SBA-backed loans, kind of what they are and maybe why they have an advantage.
Chris Hurn: So, the biggest advantage is that it may be one of the few options available to you at a reasonably priced interest rate. You know, you still have those other options I mentioned earlier, hard money loans and emerging cash advances, factory receivables, business credit cards; all sorts of things are much higher priced than what you get an SBA loan for. So that’s what occurs.
I mean, SBA lending tends to be for all sorts of uses of proceeds, much broader than, I would say, ordinary traditional lending. So the SBA’s marquee program is the SBA7A, and they’re that program. You can do just about any business loan purpose, meaning you can buy another business.
Business acquisitions are often financed with an SBA7A loan, up to $5 million. You can do the business debt consolidation that I was talking about earlier, you can get working capital and you can buy out a partner and you can get equipment financing, commercial real estate financing if it’s owner-occupied or operated for the business–just a variety of different franchise financing, leasehold improvements, all sorts of things.
Shawn Hessinger: What are some of the top reasons that people gravitate toward SBA-backed loans?
Chris Hurn: Well, the first one is, as we talked about before, in tough economic times, they tend to be one of the last options standing. But the biggest reason people tend to seek them out, even in good economic times, is that they will have a much lower down payment when doing a lot of these business loans.
Often it’s half, maybe even a third of what you would see elsewhere. Often, there are much longer repayment terms too. And that’s really important from a monthly cash flow standpoint. So instead of having a three- or five-year term with ordinary banks, you might have a ten-year term with that SBA loan. Or if you’re buying real estate instead of having a 15 or maybe even a 20-year amortization, you’ll have a 25-year situation with an SBA loan.
So, it makes a big difference because the longer the repayment term, obviously, the lower the monthly payment, which means the more positive your cash flow is. And that’s a big difference for a growing small businesses.
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One of the signals the Fed wants to see before stopping their rate hikes is an increase in unemployment. They literally want hundreds of thousands of people to lose their jobs before they believe inflation has been slowed. It’s gonna get rougher folks.
Thanks for sharing that Robert, and with many places looking to hire workers, it surges in unemployment probably won’t be happening
Fed rate hikes impact franchising, too. That includes new franchise startups and even current loans.
Let’s hope the rates go down next year!
The Franchise King®