If you borrow money from another person or institution, your loan terms more than likely will include an interest rate. This rate is essentially the cost of borrowing money that covers the service provided and the risk of lending money. It promotes borrowing, lending, and spending which keeps the economy rolling. However, interest rates fluctuate, and the rates vary amongst different loan types. Whether you are a borrower or a lender, It is important to understand the reasons for these changes.
What factors impact interest rates?
Supply vs. Demand
The supply and demand of credit determine interest rates: a rise in the demand for money or credit increases interest rates, while decreased demand for credit lowers them. In contrast, a surplus of credit supply lowers interest rates, while a reduction in credit supply raises them.
Credit supply increases when the amount of money available to borrowers rises. For example, every bank account is like a loan to the bank. The bank can use the funds in your account for its business and investment activities, depending on the type of account you open. In simpler terms, the bank can lend your money to other customers. They pay you an interest rate in exchange for using your money. When banks have more money available for loans, the economy has more credit available. The cost of borrowing, or the interest rate for a loan, falls when sources of credit become more accessible.
As lenders postpone loan repayments, the amount of credit accessible to the economy diminishes. When you skip your monthly credit card payment, you essentially owe more interest and reduce the credit available in the market. When enough people do the same thing, interest rates will rise.
Inflation also plays a role in determining interest rates. Experts anticipate that interest rates will continuously rise as long as inflation remains high. Lenders offer higher interest rates to counteract the amount they lose over time due to inflation.
The third key factor impacting interest rates is the government. The United States government creates and enforces monetary policies which determine interest rates. The rate at which financial institutions lend money to other institutions, also known as the federal fund rate, impacts the overall rate on the money that banks lend. The Fed conducts open market activities that influence these rates, like purchasing and selling previously issued US securities. When the government purchases more securities, banks are given more money than they can lend, and interest rates fall. When the government sells assets, banks drain their funds for the transaction. The banks have less money available to lend, and interest rates rise.
FACTORS THAT IMPACT YOUR EQUIPMENT FINANCING INTEREST RATE
Whether renovating your office, upgrading your equipment, or transporting items from point A to point B, you will want to do so for the least amount of money possible. Several factors determine your interest rate, including the national interest rate, the state of the national economy, your credit history, how long you have operated your business, and your company financials.
Interest rates in the United States
Banks and other lending companies charge higher interest rates for small company loans and lines of credit when national interest rates rise. The Federal Reserve typically increases national interest rates when the economy performs well.
The national economy
The United States economy also impacts interest rates. During periods of robust economic expansion, people create new firms, expand existing businesses, and increase capital equipment investments. Lower interest rates supposedly motivate business owners to seek loans or lines of credit to invest in their business and help the economy thrive.
Your credit history
Many business owners are unaware that their personal credit history impacts their financing options or lines of credit. Borrowers with good credit history have a seamless loan approval process, lower interest rates, and longer payback terms.
The length of time you have been in business
Banks and other lenders view startups and firms less than two years old as hazardous since they generally lack funding, collateral, and business credit. Banks typically want to lend money to startups or smaller firms, but they also need reassurance that the borrower will pay it back.
Your business’s finances
It is good practice to keep a close eye on your company finances, but that becomes even more important if you borrow money. Lenders look for borrowers with an attractive balance sheet, cash flow statement, and profit and loss statement. These reports can help you identify potential issues with your accounts, prevent financial disruptions, and maintain a positive cash flow.
STEPS TO GET THE BEST RATE
The good news is that there are several options for lowering your interest rate and making equipment financing more affordable.
Boost your credit rating. You can improve your credit score and establish good credit history by taking out credit and paying your bills on time and in full.
By consolidating your loan with the equipment you are borrowing, you can cut your interest rates. You will save money on interest and will not have to put your own money on the line. If you default on your loan, your lender will seize and sell the equipment you purchased with the loan to repay any losses.
ARE INTEREST RATES THAT IMPORTANT?
While it is crucial to know the interest rate, it may not be the most important part of the loan. When purchasing a brand new lawnmower, you probably would not question who made the spark plug. Do not get us wrong - the spark plug is crucial, and the mower would not operate without it. Does that mean it is the most important part? No, not necessarily. The interest rate works the same way and is not as important as many business owners believe.
Growth in revenue
When deciding whether or not to make a commercial equipment purchase, you must understand how each asset may impact your revenue. Each investment can potentially generate income for your business, so it is necessary to have the right finance team advising you through the process to maximize your profits. Without the right team, you may miss out on bidding on larger projects, adding new employees, or creating additional revenue streams.
Reduction in expenditures
Rental expenses, downtime, and maintenance expenditures can lead to inconsistent cash flows, customer satisfaction concerns, and a generally strict business model. It is crucial to know the specific financial implications each concern will have on your company. Newer, more dependable equipment will increase cash flow consistency and reduce overall expenses. Weighing these costs is crucial before deciding whether or not to take out a loan.
Gains in productivity
Even if your loan has a high-interest rate, it may be more financially responsible to use the borrowed funds to upgrade your equipment. Older machines may not have the most up-to-date technology, resulting in increased running expenses and reduced output. Employees who work with less efficient equipment are more likely to be dissatisfied with their jobs, leading to high turnover costs and other management difficulties. Therefore, upgrading your equipment can lead to increased productivity.
Cash flow is king
Low-interest rates are enticing, and getting the lowest rate possible can feel like a badge of honor. While this is a great step, it is the equivalent of earning an award for being the world's tallest short person.
At the end of the day, cash flow is king in finance. Your bank may offer a 6.5% interest rate, but the loan period is 48 months. An equipment finance firm may offer a 9% interest rate for a loan over 72 months. Your monthly payments would be lower with the 9% loan, ultimately freeing up cash flow. You can use this money to reinvest in your business in areas that yield a higher return on investment than a depreciating asset.
It is necessary to understand how interest rates change since they affect your ability to make money by lending money, bond pricing, and the amount you will have to pay to borrow money. Supply and demand, inflation, the government, your personal credit history, and your business finances are the key factors that influence your interest rate. Understanding the intricacies of interest rate calculations is critical when deciding whether or not you want to obtain a loan or line of credit.