Asset-based lending (ABL) is great for companies with equipment or inventory but not-so-great credit scores. But here’s the thing: when you get an ABL, you must choose between two interest rates, a variable and fixed.
It’s a big decision, and knowing the differences is very important for making smart money moves. It’s key to understand what sets each option apart and why some loans work better for certain situations than others.
In this article, we’ll break down variable and fixed interest rates in ABL or asset-based loans, explaining what they are, why they matter, and how to pick the right one for your business.
What Is Asset-Based Lending?
Asset-based lending (ABL) uses the borrower’s assets as collateral for the loan. These assets might be real estate, equipment, merchandise, or accounts receivable.
Unlike traditional loans, which focus on the borrower’s creditworthiness, ABL considers the value of the assets used as collateral. It makes it a popular choice for businesses with valuable assets but may have less-than-perfect credit.
Interest Rates on Assets Based Loans
When it comes to asset-based loans, the interest rates can either be variable or fixed.
Variable Interest Rate
A variable interest rate, adjustable or floating, changes over time. It’s based on a benchmark interest rate or index, meaning your monthly payment can go up or down as rates change. Rate change is important when choosing a variable rate loan, as it directly impacts the borrower’s monthly payments.
Pros:
- Lower Initial Rates: Variable interest rates often start lower than fixed rates, which can make them more attractive for short-term borrowing or for businesses expecting to improve their financial situation quickly.
- Potential Savings: If market rates decrease, the interest on the loan decreases as well, potentially saving the borrower money over the life of the loan.
- Flexibility: Suitable for businesses with fluctuating cash flow, as they can benefit from lower payments when interest rates are reduced.
Cons:
- Uncertainty: Monthly payments can increase if the benchmark interest rate goes up, making financial planning more challenging.
- Risk of Higher Costs: In a rising interest rate environment, there’s a risk that borrowers will end up paying more over the life of the loan than they would with a fixed rate.
- Complexity: Understanding how rates are calculated and what conditions cause changes can be complex for some borrowers.
Fixed Interest Rate
A fixed interest rate stays the same for the whole loan. It doesn’t change, even if the market does. Fixed-rate mortgages are popular because they’re predictable and stable.
With a fixed interest rate, you are committed to making the same monthly payments throughout the term of the loan, which could apply to mortgages, car loans, or personal loans. This consistency aids in budgeting and financial planning.
Choosing a fixed rate can be smart when interest rates are going up. It’s great for business owners wanting to expand or invest because steady payments make budgeting easier. As your business grows, the payments stay manageable.
Pros:
- Predictability: Fixed interest rates remain the same for the duration of the loan, which makes budgeting and financial planning easier.
- Risk Mitigation: Offers security against future interest rate increases, protecting the borrower from market volatility.
- Simplicity: Easier to understand for most borrowers, with straightforward repayment terms and no need to monitor interest rate changes.
Cons:
- Higher Initial Rates: Fixed rates are typically higher than the initial rates for variable loans, which could mean higher initial payments.
- No Savings on Decreases: If market interest rates fall, borrowers with fixed rates cannot benefit from decreased payments.
- Early Repayment Penalties: Some fixed-rate loans penalize early repayments or refinancing, which could limit flexibility for borrowers looking to pay off their loan sooner or take advantage of a better interest rate.
Which Interest Rate Is Better for Asset-Based Loans?
The decision between a variable and fixed interest rate for an asset-based loan hinges on the borrower’s financial stability, market predictions, and tolerance for risk. Variable rates might appeal to those with a short-term borrowing horizon or who anticipate improving their financial outlook, allowing them to capitalize on potentially lower rates in the future. Conversely, fixed rates are preferred by those seeking predictability and stability in their repayments, especially valuable in a rising interest rate environment where they safeguard against future cost increases.
For businesses leaning towards asset-based lending, thoroughly evaluating current financial health and future forecasts is crucial. Companies with a robust understanding of their cash flow and a solid strategy for using the loaned funds can make a more informed choice. Additionally, considering the overall economic climate and interest rate trends may provide insights into whether rates are more likely to rise or fall in the near future.
Ultimately, there is no one-size-fits-all answer to this question. The best choice depends on individual business needs, financial conditions, and market dynamics. We would encourage you to consult with financial advisors to tailor their decision to their specific situation. But also to consider all the necessary factors before you make a choice.
Factors to Consider When Choosing
Before deciding between variable and fixed interest rates for asset-based loans, it’s important to understand the key factors influencing this choice.
Risk Tolerance
Greater risk-tolerant borrowers might feel more at ease with variable interest rates since they are prepared to accept the prospect of greater payments in exchange for possible cost savings if interest rates drop.
On the other hand, those with a lower risk tolerance may prefer the stability of a fixed interest rate, even if it means paying a slightly higher rate initially.
Market Outlook
Assessing current market conditions and forecasts can also influence the decision between variable and fixed interest rates. Businesses may find a variable rate more attractive if they anticipate interest rates to remain relatively stable or decrease.
Conversely, if rates are expected to rise, locking in a fixed rate could provide peace of mind and protection against future increases. This is especially important for businesses taking on variable-rate loans, as they may be more susceptible to fluctuations in interest rates.
Business Needs
The business’s specific needs and goals should also be considered. For example, a company planning to expand or invest in new projects may benefit from the flexibility of a variable rate, while a business focused on steady growth and cash flow stability may prefer the certainty of a fixed rate.
Prepayment Option
Additionally, borrowers should consider whether the loan offers a prepayment option. This allows them to pay off the loan early without incurring additional fees or penalties.
A prepayment option can be advantageous for variable-rate loans as it provides flexibility to refinance or pay off the loan if interest rates rise significantly. However, prepayment options may be limited for fixed-rate loans or come with additional costs, so borrowers should weigh this factor carefully.
Understanding these financing techniques is essential before deciding between variable and fixed interest rates for asset-based loans.
Deciding Your Financial Course
In summary, choosing between variable and fixed interest rates involves assessing your risk tolerance, understanding market trends, evaluating your business needs, and considering the possibility of early loan repayment. While variable rates offer potential savings and flexibility, fixed rates provide stability and protection against rate hikes. Making the right decision for your business is crucial, and it’s important to weigh all these factors carefully.
Ready to make an informed decision for your business’s financial future? Click below to apply for a small business loan with ROK Financial and get the expert advice you need to navigate your options successfully.
