Interest Rates : Fixed or Variable

There is a perception among small businesses that banks are reluctant to lend to them, despite such Government schemes as Funding for Lending that were meant to mitigate the risks to banks.

It remains to be seen when and whether the stimulus measures announced earlier in August by the Bank of England, which included a cut in the base rate to 0.25% and a new “Term Funding Scheme”, will make a difference.

The banks’ reluctance to lend has been attributed variously to their being averse to risks and their not being able to make what they consider to be an acceptable profit on the sorts of small loans most SMEs would want. 

The interest rates on bank loans to SMEs can therefore be quite high and for some time, SMEs have been turning to other forms of finance, among them crowd funding and asset finance, to support their growth plans.

But while finance firms may be much more willing to lend for asset and business purchases, they, too are businesses and therefore need to make a profit by charging interest on loans.

Understanding finance company interest charges

Costs of funds can change week to week or month to month from finance providers depending on what is happening to market rates.

The question is whether it is worth the borrower waiting to see what happens before making a purchase and how much difference it will make. While activity is slow, as it has been in the aftermath of Brexit, it is possible borrowers might get a better deal on the items they are considering finance for than if they wait. Suppliers may have quotas to meet so could be open to offering discounts.

Another question is whether to go for a variable or a fixed rate deal.

A fixed rate can appear more expensive but it gives certainty to a business when factoring the payments into monthly overheads and cash flow.  This is one reason why such agreements are more popular. At the moment indications are that with interest rates so low, depending on your individual circumstances, this would be the preferable option.

With a variable rate deal it is important to remember that interest rates can go up or down, making it harder for a business to budget and keep on top of payments. With these loans, repayment is either by the customer making monthly capital repayments and being billed quarterly for interest, or, more commonly, where the customer makes monthly capital plus interest payments. In this case the lender keeps track in the background of whether the agreement is ahead of or behind schedule in relation to the duration of the loan.

Ultimately, the choice between fixed and variable rests on what works best for each business, but one thing is for sure, business is a dynamic process and putting growth plans on hold indefinitely is not a wise option.