If you’re looking at loan options for your small business, you have two main choices: fixed or variable interest rate loans. Variable rate loans typically come with lower rates than their fixed rate counterparts but the rate could rise over time. Fixed rate loans keep the same rate throughout the term of the loan, which can be a benefit if market rates go up, but a drawback if rates go down.
Keep reading to learn the difference between fixed and variable rate small business loans, the pros and cons of each, and factors that can help you determine which could be better for your small business.
What Are Small Business Loans?
A small business loan is money that is borrowed from a bank, credit union, or alternative lender. The borrower is expected to use the money for business-related expenses, such as:
• Working capital
• Real estate
• Inventory
• Business acquisitions
• Renovations
• Asset acquisition
There are various types of small business loans to choose from, including term loans, Small Business Administration (SBA) loans, business lines of credit, equipment financing, merchant cash advances, and more. In addition to the type of loan, you’ll also want to consider the type of interest you want — fixed or variable. Though in some cases you’ll have a choice, business Loans typically come with one or the other, so you’ll want to factor that in when deciding on the best type of financing for your business.
What Are Fixed Interest Rate Loans?
| Pros of Fixed Interest Rate Loans | Cons of Fixed Rate Interest Loans |
|---|---|
| Predictable monthly payment | Typically have higher interest rates than variable interest rate loans |
| Easy to budget for | If rates go down, you’ll be locked into a higher rate |
| Not affected by market changes | Refinancing to get a lower rate can be time-consuming and costly |
A fixed rate loan comes with an interest rate that does not change throughout the life of the loan. Once the loan is processed, monthly payments are the same until the loan is paid off. This means borrowers can easily budget for a fixed rate loan because they know exactly how much each payment is going to be. They also know how much they are going to pay for the loan overall.
The downside to a fixed rate loan is that if the market changes and banks start loaning at lower interest rates, borrowers with a fixed rate loan won’t see any changes. On the flip side, if rates go up, fixed rate borrowers are protected from any increases.
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Types of Fixed Rate Business Loans
Types of small business loans that may come with fixed rates include:
• Short-term business loans
• Long-term business loans
• SBA loans
• Commercial real estate loans
• Invoice financing
Fixed Interest Rate Loan Example
Let’s assume you borrow $50,000 to purchase an additional asset for your company. For this example, the repayment period is five years and the annual percentage rate (APR) is fixed at 7%.
Your monthly payment would be $990.06 for the life of the loan, and you would pay $9,403.60 in total interest.
What Are Variable Interest Rate Loans?
| Pros of Variable Interest Rate Loans | Cons of Variable Rate Interest Loans |
|---|---|
| Rates usually start out lower than fixed rate loans | If rates go up, loan rate will likely increas |
| May qualify for an introductory rate that is guaranteed for a set period | Monthly payments can fluctuate, making it harder to budget |
| When rates go down, borrowers will likely see lower rates | Difficult to predict total cost of the loan |
The rate on a variable interest rate loan mirrors the market, which means a loan with this type of interest may have different monthly payments from one month to the next. However, in a stable economy, the payment amounts may not fluctuate significantly.
On the plus side, variable rate loans usually offer lower interest rates than the fixed rate version of the same type of loan. And, in some cases, you might be able to get an introductory rate that is guaranteed for a set number of months. However, there are also some downsides to choosing a variable interest rate loan. Should market rates go up during your loan term, your rate (and monthly payments) will likely go up. If your business’s cash flow is tight, this can make budgeting difficult.
Another challenge with a variable rate loan is that you won’t know what the total cost of your loan will be until you’re done making payments. With a fixed interest rate, you always know exactly what you’re paying month-to-month and the total cost of the loan.
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Types of Variable Rate Business Loans
Types of small business loans that may come with variable rates include:
• Business lines of credit
• Invoice financing
• SBA loans
• Merchant cash advances
• Commercial real estate loans
Variable Interest Rate Loan Example
The previous fixed rate loan example saw the borrower take out a $50,000 loan with a five-year repayment period and a 7% APR. Overall, that borrower will pay $9,403.60 in interest over the life of the loan.
If the borrower were to choose a variable rate interest loan instead, they might be offered a 6% APR, which could be a better deal if rates don’t go up (leading to just $7,998.40 in total interest). However, if the APR goes up to 8% during the loan’s term, it could end up costing more than going with a fixed rate of 7%.
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3 Factors to Consider When Choosing the Best Loan for Your Business
When choosing whether to go with a fixed or variable interest rate loan, there are a number of things to keep in mind.
1. How Comfortable You Are With Risk
As a small business owner, you’ll want to first consider risk — and how much you’re willing to take. Many businesses want predictable monthly expenses and are willing to miss out on “historic lows” because they don’t like the idea of being vulnerable to market fluctuations.
Because of this, business owners will often choose a loan with a fixed rate.
2. Your Monthly Budget
If your business’s budget is tight, a fixed rate loan may be a good option, since you’ll know exactly what to expect each month. If, on the other hand, you have some breathing room in your monthly budget, you might want to take advantage of the lower rates that often come with variable rate loans, knowing that you’ll still be able to cover your payments should they go up in the future.
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3. The Type of Loan
Certain types of small business loans, such as term loans, come with fixed rates. Other loan types, such as business lines of credit, have variable rates. If you are set on a specific type of loan, you may not have a choice in whether or not you receive a fixed or a variable interest rate.
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The Takeaway
Both fixed and variable rate small business loans have advantages and disadvantages. Knowing your budget, financial goals, and risk comfort will help guide you when it comes to choosing the right loan for your needs.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
Is it faster to get a fixed or variable rate business loan?
The type of interest rate you receive has no impact on how long it will take to get a small business loan. Some small business lenders, such as online lenders, may be able to fund your loan within 24 hours of approval. Other lenders, such as traditional banks, may take one to two weeks to fund your loan. The type of loan you’re applying for also has an effect on funding time. SBA loans, for example, generally take much longer to fund than short-term business loans.
Which is easier to get between variable and fixed interest small business loans?
Whether you apply for a fixed or variable rate small business loan, lenders will look at your credit score, your business income, and the length of time you’ve been in business. The type of interest rate you receive does not make it any easier or harder to obtain the loan.
Are fixed or variable interest rate business loans typically cheaper?
Variable interest rate business loans typically start out at a lower interest rate than fixed rate loans. If you are able to pay the loan off quickly, or if the market rate doesn’t go up during your loan term, a variable rate loan may save you money. However, the rate on a variable rate loan can also increase over time, making it more expensive in the long run.
Do small business loans have a fixed interest rate?
A small business loan may have a fixed or variable interest rate. With a fixed rate loan, the interest rate and monthly payment won’t change over the life of the loan, making it easier to budget for repayment. Lump sum term business loans typically have fixed rates.
A variable rate loan may carry a lower initial rate than a fixed rate loan, but that rate can rise (or fall) over time since it’s tied to a benchmark rate that fluctuates with the market. A business line of credit may come with a variable interest rate.
How do you tell if a loan is fixed or variable?
You can find out if your small business loan has a fixed or variable rate by looking at your loan contract and repayment terms.
Photo credit: iStock/Talaj
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