Large businesses often require significant capital to fund expansion or other strategic initiatives. When seeking financing, one crucial decision they all face is whether to go for fixed or variable interest rates on their loans.

In fact, for those of you who don’t know, choosing the rate for your loan is possibly the most important factor when you’re considering your choices. Especially when it’s a larger loan. However, both fixed and variable rate options present distinct benefits and drawbacks. That’s why checking these differences are important in making a well-informed decision that matches your business’s objectives.

In this insightful article, you will gain a comprehensive understanding of the two key options available for your business. Giving you everything you need to make the best possible decision for you and your business.

Understanding Fixed Rates

Fixed interest rates can be defined as rates that don’t change over the life of your loan. In other words, your monthly payments will stay consistent throughout your loan term. The main advantage here is predictability and stability to businesses. Letting them accurately plan their budgets and cash flow without worrying about any sudden changes in their interest obligations.

These rates are typically the best option for businesses that prefer certainty in their financial obligations. Especially during times of economic uncertainty or if the business operates on thin profit margins. There is also a good option for long-term loans as they offer protection against rising interest rates in the market.

However, the rigidity of fixed rates can be a double-edged sword. While they shield borrowers from adjustable-rate mortgage fluctuations. They might miss out on potential cost savings if market prime rates decrease. Fixed-rate loans tend to be slightly higher than variable rates initially. This means businesses may end up paying more over time compared to variable-rate loans.

Understanding Variable Rates

On the other hand, variable interest rates are dynamic and fluctuate with changes in the market interest rates. Also, they’re tied to a benchmark interest rate. Usually, the prime rate or LIBOR fluctuate over time. So you’ll be likely experiencing changes in your rate over time based on changes in that benchmark rate. As a result, monthly payments can change. Making it more challenging to predict your long-term borrowing costs.

Borrowers may find themselves in a favorable position when market interest rates decline. Leading to reduced interest expenses. However, you should be aware that an increase in market rates could result in higher payments.

This “double-edged sword” makes it more essential for borrowers to be aware of existing and future trends in the market. They’ll need to monitor, plan, and prepare accordingly to navigate these potential fluctuations in interest rates.

Nonetheless, variable rates tend to be lower than fixed rates initially since borrowers are assuming the risk of market fluctuations.

This can make them an ideal option for businesses that can handle these market fluctuations and have a higher risk tolerance. They’re also suitable if you’re planning on paying off your loan quickly as it reduces the overall amount paid toward interests

However, there’s no guarantee that this will happen.

Business Loan Interest Rate Factors

As you can imagine, the interest rate on your loan isn’t based on a single factor but rather a series of different factors. You may not have immediate control over all the factors that creditors use. However, even being aware of them can be very helpful in determining what kind of rate you should aim for and what you should expect in your respective market.

Lender

Most financial institutions offer both fixed and variable rate options. You’ll need to pick the one that best aligns with your business needs and preferences.

Still, different lenders offer varying rates based on criteria, risk appetite, and funding costs. Traditional banks and alternative lenders each have unique pricing models. And funding costs may vary depending on whether you’re borrowing from a large bank, community bank, or credit union.

Creditworthiness

Your credit score is one of the more critical factors when it comes to financing. Borrower credit score, history, and financial stability all are factored into your potential loan rates. It helps lenders assess your risk and determine what rate you qualify for. The higher your credit score, the lower interest rates you’ll typically be eligible for.

Loan Amount and Term

Larger loan amounts borrowed over extended periods typically get reduced interest rates. Which is due to the lower risk associated with them. Conversely, smaller loan amounts taken for shorter durations usually incur higher interest rates since lenders perceive higher risk and costs with these types of transactions.

Market Conditions

Economic factors like inflation, central bank policies, and demand affect rates. Economic growth may raise rates; downturns may lower rates.

Business owners can also prepare themselves by maintaining a strong credit profile and a solid business plan showing the repayment ability to find competitive rates from lenders. Understanding these factors and working with reputable lenders can help secure favorable rates for business growth and success.

Are Most Business Loans Fixed or Variable?

This is one of the questions we get quite a bit. However, the answer varies extensively on the specific business, lender, and market conditions at play. We would advise you to focus more on picking the best possible option for you rather than trying to understand what everyone else is doing.

Ultimately, the best choice for your business will depend on your unique situation. The better your understanding of your business, your needs, your customer’s needs, and the market you share, the better position you’ll be in to make the perfect loan.

If you’re curious, a 2023 survey by the Small Business Administration revealed that a slight majority of small business loans (approximately 55%) were fixed-rate loans. Though this marks a slight decline from 2022, it does align with a clear historical trend of businesses favoring fixed rate loans over variable rate ones. But only to a small degree and never enough to remove variable rate loans as a viable option.

This minor favoritism is likely due to businesses favoring the stability and predictability that fixed rates offer. Particularly for business owners who want to prioritize long-term growth over short-term gains.

Still, business owners should investigate both options to determine the best course for them. Thoroughly investigate business needs and challenges for both present and future success.

Are Fixed or Variable Rates Better for Large Business Loans?

As we mentioned above, the “best” option will be one tailored to your specific situation. Not something that’s predetermined by current trends or established lending practices. Not to mention, what you’re trying to accomplish with your business might be vastly different from other businesses.

Still, it’s also apparent that the general rule of thumb favors fixed-rate loans for long-term loans. Borrowers generally use loans with a variable rate for smaller, shorter-term loans. That is the general objective trend if you simply need to know.

Small businesses focused on long-term growth should choose stable rates, even if they consider other factors. The reality is that data gathered from across the economy does support this rule of thumb. While we can’t lift this as a “one size fits all” solution, it is a recurring trend that we generally find ourselves recommending to our clients.

Still, do not use this reality to completely dismiss loans with variable rates. Especially if you’re not certain if long-term growth is the immediate concern. If you can compartmentalize your goal into a short-term objective, you could get a much better deal with a variable rate.

Conclusion

When it comes to choosing between fixed and variable rates for business loans, the decision hinges on various factors. Including their lender, creditworthiness, loan amount, term, and prevailing market conditions. Business owners must carefully weigh the advantages and disadvantages of fixed and variable rates before making a decision.

Businesses need to stay updated on the economy and market changes to adjust to interest rate changes. By maintaining a strong credit profile and making informed decisions, businesses can navigate the financial terrain successfully.

Ready to take your business to the next level? Explore financing options with ROK Financial and secure a small business loan today!