I’m Gregory Miller, and I’ve been Chief Economist for SunTrust Bank for the past 25 years. I’m responsible for helping clients—including small businesses—understand how today’s economic activity can affect personal and business finances.
The state of interest rates is a popular topic of discussion. Likely, you’ve heard a great deal about the U.S. Federal Reserve, its policies, and its historically low rate environment.
But what does this really mean for your business? And what do you need to know as you think about your current and future capital needs to ensure long-term financial health?
Responsibility for setting U.S. interest rates lies with the Federal Reserve. The Fed, as it’s known, is our National Central Bank and primary bank regulator. The Fed sets a benchmark interest rate that banks use to negotiate with small businesses and other borrowers. The Fed raises and lowers that policy rate in response to inflation and other economic indicators, such as the unemployment rate.
The Fed funds rate is the interest rate banks pay to obtain funds—it’s their cost of capital. In turn, banks lend at a higher rate to cover their own capital costs and the risk of potential late payments or defaults. The cost of risk is an important component because banks must judge the ability of each individual borrower to repay their loans. Therefore, if you’re seeking financing for your business, the interest rate at which you can borrow will be higher than the current Fed funds rate.
The Fed funds rate is expected to remain near zero until 2015. This creates an opportunity for your business to borrow money for equipment, for real estate or to refinance high-interest debt at more favorable rates.
Whether you’re starting a small business, expanding or funding a major expense, low interest rates make now an ideal time to seek out financing. But what if the economy begins a faster-than-expected recovery? There are economic indicators you can monitor to determine if interest rates could rise. Rising rates will affect your short- and long-term plans for financing.
*First is gross domestic product. Through 2012, the nation’s GDP was growing at a pace of about 2 percent. However, it slowed substantially toward the end of the year. If growth accelerates to between 3 and 4 percent, higher rates could be on the horizon.
*Second is the labor market. The economy has been generating about 150,000 jobs a month. If the labor market accelerates job growth to about 250,000 jobs a month, the Fed might begin to push interest rates higher.
*The third indicator is the unemployment rate. Currently it’s above 7.5 percent. The Fed has already stated it wants to see an improved unemployment rate before it starts raising interest rates. The target unemployment rate that could trigger such a move is 6.5 percent.
While changes this large do not happen instantaneously, improvement is already underway. And, planning ahead can give you time to save money.
If the economy continues to strengthen, you can act now to protect against higher rates later. Think about whether you need to finance a major expenditure, refinance a high-interest-rate loan or transition from an adjustable-rate loan to fixed. Taking action before interest rates increase is the most cost-effective decision for your business.
Keep in mind that interest rates are only part of the lending equation. New bank regulations require you to shown an ownership stake and a strong capital base to demonstrate sound financials when seeking financing.
For example, you can expect to show your lender documentation that showcases your business’ financials—both current and future numbers. Your income and cash flow statements, as well as your balance sheet, provide insight into your current operations. Lenders might also ask for a pro-forma statement to project your company’s future performance.
Planning and preparation go a long way toward demonstrating how attractive your application appears to bank lending officers.
This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.