Interest rates are crucial for small business owners to understand, especially those who borrow money via business loans or lines of credit, as well as those who earn interest on their business checking account. With rates frequently fluctuating, it’s also important to know why changes might occur.
Let’s explore what different types of interest rates are, and what may cause changes over time.
What you need to know
- Eight times a year, the Federal Reserve decides whether to change national interest rates, with the goal of encouraging or discouraging economic activity.
- Interest rates go up when inflation and unemployment are high, and go down when inflation and unemployment are low.
- When interest rates are high, pay off existing debts, limit borrowing, and maximize your operating balances by using high-yield business checking accounts.
What is an interest rate?
Interest is the amount you have to pay to borrow money. An interest rate is the percentage of the principal amount that you owe. For example, if you borrow $100,000 at a 5% interest rate, then your interest is $5,000, and you’ll need to repay $105,000 in total.
Interest rates can vary from under 5% to over 20% depending on your business credit profile, the type of financing you select, and the national federal funds rate set by the Federal Reserve (more on this below).
While high interest rates increase the cost of borrowing, they can also work in your favor: You can earn interest on your balance when you deposit money into a business bank account. It’s a common misconception that only business savings accounts will generate a return—the best business checking accounts will let you earn interest on your operating balances, saving you the trouble of transferring money back and forth between accounts.
What’s the difference between APR and APY?
The annual percentage rate (APR) is the yearly interest you’ll pay for any sum that you borrow. On the other hand, the annual percentage yield (APY) is the yearly interest that you will earn from an interest-bearing account.
The most common use of an APR is when you borrow money with a loan. For example, if you take out a $10,000 business loan with 5% APR, then you’ll be required to pay 5% interest on the outstanding principal until the loan is repaid.
On the other hand, the most common use of APY is when you open a business checking account that earns interest. For example, if you deposit $10,000 into a high-yield checking account that generates 1.5% APY, then you’ll earn 1.5% on your balance. Of course, interest rates are in a constant state of flux and earned interest is typically paid out on a monthly basis, depending on how your bank calculates interest.
Earn more and pay less with Bluevine Business Checking.
What causes interest rates to rise and fall?
Interest rates are influenced by a number of different factors, including inflation, economic activity, and the national rates set by the Federal Reserve. The basic process of interest rate change works like this:
- The 12 members of the Federal Reserve’s Federal Open Market Committee meet eight times per year to discuss monetary policy.
- On the second day of their meeting, the Federal Reserve proposes policy changes that either encourage or discourage economic activity. It does this by adjusting the federal funds rate, which is the rate that banks charge for short-term loans to other banks.
- When the federal funds rate changes, banks then change the prime interest rate, which is the interest rate they charge their customers. This affects how much business owners pay for lines of credit, term loans, credit cards, mortgages, business checking accounts, etc.
Did you know?
In general, the Federal Reserve lowers interest rates to encourage borrowing and stimulate the economy. If the economy starts to grow too quickly, the Fed will raise interest rates to discourage borrowing and slow economic activity.
When will interest rates go down?
Interest rates change depending on the actions of the Federal Reserve and the economy at large. While it’s difficult to say when exactly interest rates will go down, they tend to go down gradually when inflation and unemployment are both low. Rate changes are always announced on the second day of Federal Open Market Committee meetings.
What should I do when interest rates change?
Whether increasing or decreasing, changes in interest rates will affect your business finances:
- When interest rates are higher, borrowing money is more expensive, so it makes sense for business owners to pay down existing debt, limit the amount they borrow, and take advantage of high-yield business checking accounts.
- When interest rates are lower, borrowing money is more affordable. During these cycles, it’s a good idea to apply for a line of credit if you think it can help grow your business.
How do business loan interest rates work?
Business loan interest rates work like other types of interest rates. When you apply for funding, the lender will evaluate your business’ financial situation to determine the terms of your loan. For business loans, lenders will typically look at factors like your business and/or personal credit score, business income, and the length of time you’ve been in business.
The process is similar for a business line of credit, which offers a replenishing pool of funds like a credit card. As your business repays the money it borrowed from your credit line (along with interest owed), credit is replaced and becomes available again.
See how Bluevine can help fuel growth with business loans that fit your needs.
