The U.S. Small Business Administration (SBA) government-guaranteed loan program provides long term financing for small businesses with lower down payments, longer repayment terms, and easier qualifying criteria than conventional bank loans. While SBA lenders offer competitive interest rates, and while the SBA dictates a maximum interest rate participating lenders can charge their borrowers, most small business owners do not choose SBA financing just for the lowest or fixed interest rates.
Why would a small business owner not insist on a fixed rate of interest for their loan in a rising interest environment? Why choose an SBA loan with an interest rate that may go up, increasing the monthly payment amount? First, we must recognize that any small business loan request contemplates paying a price for the privilege of using the lender’s funds to benefit and grow the success of the business. Here are some reasons a floating-rate or variable SBA loan may be more beneficial for a small business, even in a rising interest environment:
- The small business owner is declined for the loan request by their primary bank. Banks change owners, management, policies, and their loan appetites change. Small banks are acquired by larger banks, which may prefer to do business with middle market or public companies rather than smaller businesses. The bank’s loan decline does not mean that the small business loan request doesn’t have merit for an SBA lender.
- A small business can easily afford a slightly larger payment in a rising interest rate environment. A rising interest rate environment generally occurs during a stronger economy, when a small business can increase its income and afford to pay a slightly larger loan payment due to an interest rate adjustment.
- Banks by nature are short-term lenders, because bank regulators require them to remain liquid with their depositor’s funds. SBA loans are generally long term loans. Even though banks provide long term financing, it must be offered in short term segments. This means the small business is subject to review and re-approval of their loans every 2, 3, or every 5 years. Even if the interest rate was fixed on the short-term bank loan, if the Wall Street Journal Primate Rate has risen, the bank will be charging a higher interest rate at loan renewal. In effect, fixed rate bank loans are really variable rate loans over the long term.
- The small business wants to borrow more money with a lower down payment requirement than is required with conventional financing. SBA lending is famous for its lower down payment. SBA borrowers can qualify for financing with down payments as small as 10% of the project cost; whereas, conventional bank financing may require down payments more like 20%-30% of the project cost.
- The small business would like to avoid bank loan renewal risk and obtain long-term, permanent financing with an SBA loan. This may be important to the small business owner, because he does not know who will own the bank, or be in control of management and loan decisions, when the short-term bank loan comes due for renewal. The small business owner may not want to risk not having his short term bank loan renewed due to a temporary downturn in the economy or during a down cycle in his business. Long-term, permanent SBA financing eliminates bank loan renewal risk.
Bottom line: SBA financing has provided a relief valve for the funding of small business financing needs for many years. Small business entrepreneurs are risk assessors on an everyday basis in their businesses. They must weigh the benefits of a variable rate SBA loan against the option of not using the loan. Many find that it suits their needs better than other conventional loan sources.