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Opinion: How to borrow money in rising rate environment

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Over the past several months, the Federal Reserve – the central bank of the United States – has increased its policy interest rate and indicated it likely would continue to do so until inflation is under control. These increases have made it more expensive for banks to borrow money, resulting in the rising interest rate environment we’re currently experiencing.

This hot topic has led economists and financial forecasters to warn about worst-case scenarios, including a recession. It can be difficult to understand how the Fed’s actions, and subsequent reactions, might affect businesses now and in the future. But to do so, we first need to briefly revisit the past.

History of interest rates
Going back to the Great Recession, the Fed lowered interest rates in 2008 close to zero. They stayed at incredibly low levels until 2016, when the economy started to heat up and the Fed raised rates once more to keep inflation in a target range of 2%-2.5%.

In late 2019, COVID-19 sparked severe economic impacts on the global economy. In response, the Fed again lowered rates to practically zero. At the same time, federal loan programs like the Paycheck Protection Program provided further support and supplied businesses with reserve liquidity, helping ease the burden of demand and leading to increased levels of employment.

However, supply chain issues emerged as the world’s largest providers instituted new protocols. Raw materials became more difficult to acquire, stretching out the time it took to produce any given product. The supply chain pinched the availability of raw materials and finished goods, forcing consumers to pay more for them. You know this by a particular buzzword: inflation.

Boosting interest rates is a lever of sorts for the Fed to control inflation. Higher interest rates make it more costly for businesses to borrow money through loans and lines of credit, and they affect how much interest you pay on your credit card or home purchases. The impact of this generally ripples through the overall economy.

In September 2022, the Fed raised interest rates by 75 basis points for the third consecutive Federal Open Market Committee meeting. These 75-point increases are an aggressive action compared with more typical Fed rate increases, which in the past moved in 25-point increments. It was the largest rate hike since 1994, and the latest news indicates markets expect the Fed to raise rates again in November as well as December.

What can businesses do?
First, consult your banker, accountant and attorney. Life is easy when demand is strong and rates are low. These key partners, especially those with experience in your industry, can help you navigate chaotic times.

Think of these important relationships as an extension of your team dedicated to providing individual advice and insight. You should be able to bring your plans or scenarios to your trusted advisers to assess their viability and impact on your business.

Sometimes, these partners may say things that are tough to hear, but honest communication both ways is important in any long-term relationship. Bankers should provide best practices, insight, advice and ideas to help you find solid footing.

While every business and industry is unique, maintaining cash flow is vital to success. Consider how rising interest rates impact your business in each of these situations:

  • Borrowing money in a rising rate environment becomes more expensive for both operating lines of credit and term loans through higher borrowing and capital costs.
  • Operating lines are impacted quickly as many lines of credit are repriced daily.

If you are about to buy a piece of equipment, real estate or a business, be sure you know the return for that investment decision in basic terms. Rates may reach a level that impacts these assumptions.

You and your adviser team should consider how to structure a loan, including evaluating the amount of cash involved in the transaction, trade-offs relative to longer or shorter amortizations and the overall debt capacity of your business.

Rising rates are nothing new, but they can make for turbulent times. Still, you and your business can continue to thrive through it all.

Ryan Sutherland is a senior vice president and senior commercial lender for Old Missouri Bank. He can be reached at r.sutherland@oldmobank.com.

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