When you apply for a loan, your agreement will have either a fixed or an adjustable interest rate. A fixed interest rate is just that – an interest rate that does not change throughout the life of the loan. An adjustable interest rate will change as market conditions change and interest rates rise and fall across the economy. Determining the best agreement structure for your business depends largely on the type of loan you're looking to take out, the economy's current market conditions and the length of your loan term.
Booming economic conditions precipitate rising interest rate environments. This happens when the Federal Reserve raises interest rates to curb inflation. In falling interest rate environments, the Fed lowers interest rates to spur economic growth. As of October 2018, the U.S. economy has been steaming forward into its most productive years since the Great Recession. This has created a rising rate environment where the Fed is looking to stifle runaway economic growth and prevent inflation.
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It may seem straight forward, but there are many factors that go into choosing between a fixed and adjustable interest rate loan. This can be confusing, so it's important to understand the difference between the two types of interest rates as well as the pros and cons of each. [Interested in getting a business loan? Check out our best picks of providers.]
Fixed interest rates
Fixed interest rates make it easier to predict how much your loan will cost you. Because your interest rate remains fixed throughout the life of your loan, you can easily understand exactly how much you'll be paying for your loan.
A major advantage to fixed interest rates is having the opportunity to lock in a loan for a low cost as rates rise. The predictability and advantage can only be reaped if rates continue to rise. If they fall, you'll be on the hook for a higher interest rate than the rest of the market.
The main difference between fixed and adjustable interest rates comes down to risk. Fixed interest rates, while the more conservative choice, could mean you end up paying more for your loan than others. Adjustable interest rates are more of a gamble.
"The nice thing about a fixed rate loan in any interest rate environment is you know what you're going to pay and for how long," Cussen said. "With an adjustable rate, there's always a level of uncertainty."
Adjustable interest rates
Both a pro and con for adjustable interest rates is that they're flexible and will change throughout the course of your loan. The pro in this situation is they could be less expensive over time as interest rates fluctuate.
"If interest rates are high, then an adjustable rate loan may be more attractive if interest rates are starting to come down," Cussen said. "Because then your payments may go down overtime instead of up."
The key to adjustable interest rates is assessing current market conditions. View the past few quarters of Fed policy, anticipate growth or economic slowdowns or analyze your own businesses revenue and productivity. For long-term loans, adjustable interest rates may only make sense if interest rates are falling.
If you're looking into short-term loans in a rising rate environment, however, you may be able to take an adjustable rate and not have to worry about rate increases – your own increased revenue (if you're reaping the benefits from the positive economic times) could offset a minor interest rate increase. This will, of course, depend largely on your business's own economic situation and borrowing goals.
The longer your loan term, the bigger the weight on your decision between fixed and adjustable rates. If you're in a rising rate environment looking for a long-term loan, Cussen said it's best to lock in a long-term loan as soon as possible. This ensure you'll get the best rate you can.
If you're looking for a short-term loan, it decision between fixed and adjustable interest rates holds less weight. If you're in the market for a business loan, Cussen said it's a good idea to move quickly and try and work with multiple lenders.
"Don't be afraid to shop around," he said. "See if you can get prequalified, because if you can tell a lender you've been prequalified by some other lenders, that may give them more leverage."