How To Prepare Your Business When Applying For An Asset Based Loan

How To Prepare Your Business When Applying For An Asset Based Loan

Asset Based Loan

 

If your business has a good mix of tangible and intangible assets, an asset based loan can be a great way of accessing working capital. You can use the funds from asset based loans to purchase inventory, finance accounts receivables, or even hire additional staff.

Like other forms of financing, there is a process when applying for an asset based loan. Here are some thoughts on how to improve your chances of approval. Consider these 5 steps when applying for an asset based loan.

 

1. Prepare a Sound Business Plan

 

While asset based loans are secured by company assets, lenders will still need to know how you plan to use the additional funds. Additionally, it is important that you not only have the assets to support the loan, but also the cash flow from operations to make the monthly payments. Therefore, prepare a business plan that includes how the funds will be used, your vision for growth, and a clear path to success using the borrowed funds. Lenders need to clearly understand the use of funds and how they are going to benefit and grow the company going forward. 

 

A sound business plan inspires confidence in the lender and will help you secure a more competitive rate. In some instances, as is the case with contract financing, you can negotiate flexible repayment terms based on the cash flow of the contract because the lender understands your goals and how you plan to achieve them.

 

A solid business strategy will also open doors for establishing a long-term relationship with the lender. In this way, you can access future lines of credit whenever you need additional funding. 

 

2. Value Your Assets

 

Asset based lenders typically accept both tangible and intangible assets as collateral. However, lenders prefer liquid assets such as cash, securities, and inventory items that are easy to sell. Accounts receivables with quick payment cycles are also valuable assets.

 

Additionally, lenders may consider the long-term value of fixed assets such as real estate, business equipment, and even office furniture. Conduct a thorough valuation of your assets as you prepare your application. Determine how quickly your fixed assets depreciate, and provide an honest assessment backed by an independent appraiser.

 

It’s not uncommon for lenders to assign a lower value to your assets than you expected. Asset based lenders will lend a percentage against the “cost value” or “liquidation value” of the assets to minimize their risk. It is important to understand that asset based lenders are not equity investors, they are debt providers. As such, they look to the the value of the assets being used as collateral and the cash flow of the company. They are not in the market to provide funding for the promise of future returns and ownership interest, like equity firms are. It is a common frustration our clients have when they first start exploring asset based loans. The expectation is that they will receive debt priced financing with an equity investment structure. This, unfortunately, doesn’t exist. 

 

3. Prepare your Business Documents

 

In addition to having a sound business plan, prepare supporting documents that shed light on the state of your business. Asset based lenders typically will request the past two years of tax returns, year-end financial statements, current interim financial statements, past 6 months of bank statements and your accounts receivable and accounts payable aging reports. If you are using equipment or inventory as collateral, they will need an estimated value of each. Appraisals on real estate and evaluations on inventory and equipment are required as part of the lender’s due diligence.

 

You will also need to provide identification documents for yourself and your business. These documents may include articles of incorporation, a brief description of business operations, and your driver’s license. 

 

4. Negotiate Terms 

 

Because asset based loans are a form of secured financing, lenders are not boxed in to defined parameters and terms are negotiable. Often times, rates, terms, fees and loan structure are negotiable. There is more room to negotiate when your debt service ability (ability to make the monthly payments) and asset quality are high.  In an inventory financing or accounts receivable financing scenario, you can negotiate discounted terms from suppliers if you have the cash on hand to cover your cost of goods. Discounts of 2%/10, N30 are common and a reduction in your cost of goods, partially offsets your cost of capital. This is how the majority of our clients mitigate the finance cost and leverage their companies in a responsible way to facilitate their growth. 

 

You can negotiate rates, terms and fees with the lender and then negotiate discounts with your suppliers in exchange for early payment. 

 

5. Catch Up on Your Accounts Receivable 

 

If the majority of your accounts receivable are aged past 60 days, this will have a detrimental effect on the lender’s decision. Regardless of the type of asset based loan being requested, lenders analyze the accounts receivable to measure the cash flow cycle of the business. If your accounts receivable are stretched, it could indicate future cash flow problems. Lenders like to see that the accounts receivable are being collected within industry norms. Additionally, your accounts payable should be paid as promptly as possible and always be less than your accounts receivable. If your accounts payable are larger than your accounts receivable, this is referred to “negative working capital” and is a red flag in the credit review process. Simply put, your company owes more money than it is collecting and this is a concern for all lenders. 

 

In an accounts receivable asset based loan, collection days and collection percent are closely reviewed. The lender wants to know that you have control of the credit you are extending to customers. Collection within terms and collected amounts equal to the amounts billed are key indicators of asset quality. If your accounts receivable are stretched this could be an indicator that your customer credit profile is poor. Deductions taken on the amounts billed could point to poor product quality and customer dissatisfaction. Both items are areas of concern for the lender and weigh heavily on their credit decision.

 

Are you ready to apply for an asset based loan and grow your business? Huntington Coast Capital can help. We’re your one-stop resource for asset based funding, working to connect businesses with funding options that enable entrepreneurs to achieve their goals. Contact us for a consultation today! Apply online or call at 844-239-2632 to discuss your business growth plans!

 

Accounts Receivable Financing | Huntington Coast Capital

Accounts Receivable Financing | Huntington Coast Capital

 

If you are a business owner or financial manager, you know that cash flow management can be a challenging task. One tool that can help businesses address short-term cash needs is accounts receivable financing. In this article, we will provide an overview of what accounts receivable financing is, how it works, and the benefits to help you decide if it is the right option for your company.

 

Accounts Receivable

Accounts receivable financing helps businesses secure a line of credit by offering their accounts receivable as collateral. Accounts receivable are amounts that a company expects from its customers for goods or services that it delivered, but have not yet received payment for. Accounts receivable are company assets, because they represent future cash inflows that the company expects to receive. By securing a line of credit against your company’s accounts receivable, you are able to improve and level off the capital needed in your business. 

 

Mechanics

During your operations, your business will gradually accumulate credit from customers that have yet to pay for your products. However, you might need to pay recurrent expenditure like wages or bills and might require funds immediately. If the customers cannot pay within the time you require funds, a financing institution can lend you money minus the fee based on the amount of accounts receivable, business type, and industry.

 

Types of Accounts Receivable Financing

Accounts receivable financing is delivered in different forms depending on how the loan is structured between the financial institution and the borrowing entity. Asset sales, factoring, and loans are three types of financing arrangements that businesses can use to access funds based on their accounts receivable.

 

Asset sales

In an asset sale, a company sells its accounts receivable, a current asset, to a financial institution in exchange for immediate cash. The financial institution then becomes responsible for the credit and collection from the customer. Asset sale financing can be a useful option for businesses that need to access funds quickly and are willing to sell their accounts receivable at a discount. Also known as a “non-recourse” transaction, the invoices used as the collateral are purchased outright at a discount whereby the purchaser takes the risk of collection. This financing option is typically only available when the invoices being purchased are from large, credit-worthy institutions. 

 

Factoring

Factoring is a financial arrangement in which a lender provides a business with funds based on the value of its outstanding invoices. The lender evaluates the invoices and decides to fund a percentage of their value. The business then receives the funds upfront and uses them to cover everyday expenses. The lender charges a fee for this service, which they deduct from the proceeds of the invoice when the customer settles their debt. Unlike an asset sale, a factoring agreement is ongoing and accounts receivable are used on a daily basis as invoices are generated by the borrower. It is a line of credit that grows as the business grows using the accounts receivable as collateral. Advance rates range from 50% to 95% depending on the collection quality experienced by the business and industry as a whole. For example, in the temporary staffing and trucking industry, advance rates of 95% are fairly common because the invoiced amount is typically paid at full value. Conversely, in the healthcare industry where invoices are sent to insurance companies for payment, a much lower advance rate is given due to the reduced payments experienced in the industry (i.e. invoiced amount may be $10,000 and collected amount could be $7,500 based on what the insurance company deems as eligible). 

 

Loans

A loan is a financial arrangement in which a lender provides a business with a set amount of funds the business must pay over a fixed period, including interest. These are referred to as term loans. Businesses can use term loans to finance accounts receivable; however, the collateral is usually a blanket lien on all assets, including accounts receivable, in these scenarios. Term loans are used to cover fixed expenses such as acquisition of real estate, acquisition of a business, tenant improvements, new equipment, marketing and advertising, hiring, etc. Term loans usually include a 10-year amortization (the “fixed period”). Loans are the only option in accounts receivables where the business does not pass the accounts receivables to the financial institution. Rather, the accounts receivable are a part, together with other assets such as inventory and equipment, of the total collateral for the loan. 

 

Benefits

Unlike traditional business loans, institutions approve and fund accounts receivable financing quickly, often within a few days. Thus, this financing method makes it a good option for businesses that need to access cash quickly.

Many types of financing, such as business loans, require collateral to secure the loan. With accounts receivable financing, the only collateral is is the accounts receivable. This makes accounts receivable financing and attractive and easier to obtain form of financing to enhance the working capital of your business. 

Minimal paperwork and easy application process: The application process for accounts receivable financing is generally simpler and requires less paperwork than traditional business loans. This can be a significant advantage for businesses that are short on time or resources. There are fewer covenants and restrictions contained in accounts receivable financing contracts, making them an attractive option for most when compared to traditional bank financing. 

Accounts receivable financing can help businesses smooth out their cash flow and make it easier to plan for future financial needs. This kind of financing is especially useful to businesses with rapid growth but slow cashflows. They receive the funds they need and worry about debt collection later.

 

Contact us at Huntington Coast Capital to discuss your accounts receivable financing needs or call 844-239-2632. We look forward to bringing value to your business! 

 

The Difference Between Bank Asset Based Loans And Private Asset Based Loans

The Difference Between Bank Asset Based Loans And Private Asset Based Loans

Huntington Beach, CA  Owning a business takes a lot of cash on hand. Cash to make payroll, pay rent (or a commercial mortgage), purchase supplies, marketing and advertising, etc. Business owners reach out first to the bank they have their business deposits with to see if they can provide them with a loan. Their bank is a good place to start, and if they can qualify, their journey ends there.

Different types of asset based loans.

Asset based loans can be made against any asset seen on a company’s balance sheet. The common assets used as a collateral for a loan are real estate loans, equipment loans, inventory and accounts receivable. Other collateral considered assets by a lender are purchase orders and supply chain funding lines.

Asset Based Loans Obtained From Banks. 

Banks provide asset based loans, but have stricter requirements than the private sector. The first difference you will notice is that a bank will most typically require you to open a deposit account with them in exchange for doing the loan. Depending on the size and type of asset based loan, the bank will require you to switch you entire banking relationship over them as a requirement for doing the loan. Switching your banking relationship is no easy or convenient task.

If deposits are not required, that means that the bank will look to fit you in to an SBA loan program. Banks mainly offer term loans under the SBA loan program versus revolving lines of credit. Loans made against accounts receivable, purchase orders or for supply chain funding are not on the menu for most banks.

The preferred type of asset based loan banks like to issue are for real estate and equipment purchases. The range of your required down payment will depend on the type of loan being considered, your business and personal credit and the amount of liquidity you have on hand post purchase. Most banks set their bottom limit at a 680 credit score or better to be considered for an asset based SBA loan.

Private Sector Asset Based Loans. 

In the private sector the whole credit picture is also considered, but not scrutinized quite as closely. The main consideration is the asset quality itself. For example, in an accounts receivable loan, the credit quality of customers, average collection days and historical bad debt write offs are of paramount importance. The private lender will look at business and personal credit scores and evaluate the company’s financial position, however they will also listen to the story. Many business owners have lower credit scores because all of their cash has gone in to their business and this sometimes creates issues meeting their obligations on time. The private asset based lender understands that an asset based loan will improve the company’s cash and allow them the growth opportunity they wouldn’t otherwise have without access to capital. This especially true when considering loans to finance purchase orders or establish a supply chain line of credit.

What Asset Based Loan Is Right For Your Business? 

Our advice is to always check with your business bank first. They are the ones that have the experience with your business and it’s always prudent to confirm their ability to assist.

The facts are that most business owners do not qualify for bank loans. This is the reason there is a market for the private asset based lender. Private capital can be used as a bridge or as a permanent financing for those that prefer less oversight from their lending partner.

What Value Does Huntington Coast Capital Bring?

In a word, experience. We have decades of experience in the private capital and institutional capital markets. We navigate our clients through the options, saving them time and when finding the right asset based lending partner for their business. If your business could use some additional capital to purchase equipment, real estate or to finance growth opportunities, we would like to speak with you.

Call us to learn more 714-719-8966.

Why You Do Not Need Good Credit For An Asset Based Loan

Why You Do Not Need Good Credit For An Asset Based Loan

Huntington Beach, CA

In the lending world, so much relies on personal credit as part of the analysis. Strong personal credit is something not everyone has, fewer than you think in fact. As business owners, when payments are delayed, you are forced to delay your payments to suppliers. However, because your business income is your primary source of income (in most cases), this means personal obligations can also be delayed. Timely payments on items such as your personal mortgage payments, electricity bill, car payments, and so forth all attribute toward your credit score. Delays in revenue and income from your business can quickly effect your personal life and negatively impact your credit score. A poor credit score makes it nearly impossible to be approved for additional credit.

Asset based loans come to the rescue in these cases! Asset based loans can be used for either real estate or business loan purposes. Let us explore below.

Asset Based Loans For Business.

The company balance sheet reflects all the assets of a business (remember assets, minus liabilities equals equity?). Assets that can be used as collateral for an asset based loan are accounts receivable, equipment, inventory, and real estate (more on asset based real estate loans below).

Accounts receivable are payment obligations from customers for goods purchased or services performed. An accounts receivable invoice reflects the amount due and when payment is expected (usually with 30, 60 or 90 days). These invoices are considered assets and can be used as collateral for a loan.

There are two types of asset based loans available against invoices and those are factoring loans and an asset based line of credit. A factoring loan is a buy sell agreement where the factor provides and advance against the face amount of the invoices to improve the cash flow of the business. Factoring loans are more than just an advance. In a factoring arrangement the factor manages the back office and credit and collection functions for the client. Outsourcing the back office functions is often more cost effective than hiring internal staff. For more information on factoring loans click here.

An asset based accounts receivable line of credit provides an advance against accounts on a total availability In this type of arrangement the lender looks at the accounts receivable aging and advances against the total balance outstanding. There is no back office management involved in an asset based line of credit and as such, the rates are a bit lower.

Asset based loans against inventory and equipment are just as you would expect. The lender advances against the value of the collateral. Proceeds are used to increase working capital and assist in growing the business. Equipment loans have been a major source of growth for us in the asset based loan category. For more information on this type of loan please visit our sister company Equipment Finance Quotes.

Asset Based Loans For Commercial Real Estate. 

Commercial real estate transactions also use asset based loans on a broad basis. If you have a traditional property type and have plenty of time to close using a bank is your best bet. High scrutiny in underwriting translates in to lower rates although the process can be tedious.

Asset based loans in commercial real estate are used as bridge loans to acquire property. Scenarios where time is of the essence or where a property requires creative underwriting, fit well with asset based commercial loan requests. Virtually all property types are considered and the process is much faster and much less document intensive than traditional bank loans. For more information on asset based loans for commercial real estate click here.

You noticed that I did not mention personal credit in any of the explanations above. This is because it does not come in to the analysis to any important degree. The only exception to this is if the borrower has a negative mark on his credit where a lender providing a similar loan took a loss on that loan. Poor credit due to inquiries, slow payment of personal obligations, charge off notices, default on credit cards and the like rarely come in to play. The main focus is the quality of the asset being used as collateral.

I hope you enjoyed reading this. If your business could use an asset based loan or if you need an asset based loan to acquire commercial real estate, give us a call at 714-719-8966.

To your success!

Patrick Zazueta | Managing Director
Huntington Coast Capital, Inc.

Huntington Coast Capital Secures $300,000 Factoring Line Of Credit

Huntington Coast Capital Secures $300,000 Factoring Line Of Credit

Huntington Beach, CA  An advertising company is the latest example of our asset based loan success stories! The company specializes in Social Hotspot/WiFi Advertising. Their slogan, WiFi is Smart. Phones are Smart. Is Your Advertising Smart? says it all. Their ability to target the audience of their clients with real time advertising sent to the target customers cell phone, is a powerful and engaging marketing concept. They can target age, gender, interests, location and more, to drill down and put the appropriate ads in front of people that would have the most interest. Targeted mobile marketing is the wave of the future in advertising!

The Challenge: Like most of our clients, they were growing quickly and struggling to keep up with the day to day working capital needs of the company. They needed an asset based loan secured by their accounts receivable to speed up their cash cycle. However, this was a more difficult funding request due to the fact that they bill their customers ahead of services rendered. I would estimate that 99 percent of the asset based loan providers that are lending on accounts receivable need to finance the invoices after the service or product has been delivered. We literally spoke with over a dozen companies to discuss a factoring loan for this client. After several attempts we found success with a progressive and forward thinking asset based loan lender. They secured the working capital loan they needed and can now grow the company without worry of running out of cash to support their growth!

If your company could use an asset based loan for your business or an asset based loan secured by commercial real estate, we would like to hear from you! We enjoy these success stories and would like to feature your business in the next one!

To your success!

Patrick Zazueta | Founder
Huntington Coast Capital, Inc.
714-719-8966 direct

Asset Based Loans Versus Bank Loans. Which Is Better For My Business?

Asset Based Loans Versus Bank Loans. Which Is Better For My Business?

Huntington Beach, CA: Our clients come to us with an asset based loan or financing need that almost always is required in order to grow their business. If you are like most business owners, cash flow is tight and if you receive a big order outside the normal course of business, it could be challenging coming up with the cash to cover the cost of goods and deliver the product. Your cash need could also be to finance additional equipment and require an asset based equipment loan in order to meet the increased capacity required to fulfill a contract.

Traditional banking places the emphasis on the cash flow and financial strength of the company, the borrower. They are primarily concerned with how financially solid the company they are lending to is. This is good practice, and it makes sense that the companies that the banks deal with are in good financial health. The obstacle to clear however, is that most companies are leveraged to a high degree and can not meet all of the required ratios banks look for when making a credit decision.

If your company is growing quickly and every dollar is going back out the door to cover ongoing working capital needs, it is likely that you will not meet all the requirements of bank lending. For example, banks look at the leverage ratio of the company. This ratio is figured by dividing the total debt of the company by the equity of the company. Equity being the total assets minus the total liabilities. If you have more than 3 or 4 times the liabilities as you do equity, banks will shy away from offering you more credit for fear that your profits and company cash flow will not be able to pay off the new debt. Again, a prudent way to look at things, but the problem is that most borrowers do not qualify.

The advantage to bank lending is the cost. If your company can qualify, then banks will be able to offer the lowest borrowing rates.

The other option are asset based loans. Asset based loans have a broad spectrum of categories. An asset based loan can be used for commercial real estate purchases, inventory loans, equipment loans and purchase order financing to name a few. In an asset based loan, the lender is looking at the asset being used as collateral in the transaction. For example, if your company received a large purchase order and needs additional cash to pay the upfront costs or deposit required by the supplier, and asset based loan is a good option. The asset in this instance is the purchase order itself. Purchase order financing is often accompanied by a factoring loan. Factoring loans are asset based loans secured by the invoice sent to the customer versus the purchase order sent to the supplier. For more information on factoring loans click here.

In our experience, business owners are qualified for asset based loans more often than bank loans. We explore each option as appropriate and the obvious choice is always revealed in the end. Our clients like the unbiased consultation and industry insight we bring to the table. Because we are not lending our own money and acting in a consultant capacity, we are able to align ourselves on your side of the table and deliver the best options for you and your funding needs. Additionally, in the majority of cases, our services are free to our clients. Our lender network compensates us for bringing them asset based loan opportunities.

If your business would benefit from an asset based loan or equipment loan, give us a call. My direct line is 714-719-8966.

To your success!

Huntington Coast Capital Presents At The Cove At UC Irvine Applied Innovation

Huntington Coast Capital Presents At The Cove At UC Irvine Applied Innovation

Huntington Beach, CA  Entrepreneurs from around the southwestern United States came to The Cove Applied Innovation Center at UC Irvine to pitch their business plans in an effort to raise capital from venture capitalists and equity investors. The companies in attendance ranged from pre-revenue, startup concepts to established companies looking to take their business to the next level. A broad range of industries were represented some of which were video game developers, niche apparel companies, foam mattress engineers, craft tea brewers, education service platforms, and airline sanitation concept companies. There were also medical technology companies represented in the area of liver function testing and patient records management.

The energy in the room was high with business owners given either 1-minute or 5-minutes to present their business and plans for the future and the opportunities that existed. The time frames were offered at different ticket price levels. The pressure was on from the beginning as the moderator kicked of the program by stating bluntly, if you can not explain your business and justification for investment in the first minute, the investors will not listen to what you have to say in the second minute! 

After the entrepreneurs were placed in the hot seat to present with hundreds of eyes fixated on them, the panelists were given the opportunity to ask questions about the business to dig deeper to see if an investment opportunity existed. Feedback was direct and pointed as the venture fund and equity groups inquired about the financial details and assessed the likelihood of earning a return on an investment. Investor comments were direct, cold and objective as they assessed the quality of the opportunities being presented.

Huntington Coast Capital was at the program to discuss the other side of business lending, asset based loans. Successfully securing an equity investment for your company is a gratifying feeling. It is an acknowledgement from discerning and critical investors that your business plans have merit and potential. Sometimes, this endorsement and confidence can be supported with investments of over a million dollars!

The harsh reality is however, that very few companies earn the privilege of an equity investment. These equity groups are reviewing upwards of three business investment opportunities per day. I often equate companies looking for an equity investment as sea turtles. Millions are born and sadly only a few hundred make it to open water!

This success ratio can be discouraging. However, when companies can not qualify for an equity investment, capital may be available on the debt side. If you are looking for money to hire staff, complete research and development of a product, market your company or gain inroads to supplier and customer contacts, equity is a great option. Conversely, if you are looking for funds to cover purchase orders or improve your working capital cycle, an asset based loan is a better option. You should not give up equity in your company if all you are looking to do is cover your cost of goods, purchase equipment or increase your inventory to meet demand. These capital expense items are all met with asset based loans.

Huntington Coast Capital specializes in securing asset based loans for companies of all sizes throughout the United States. Our typical funding amount is anywhere from $250,000 to $1,500,000. If you have solicited an equity investment with no success, look in to an asset based loan. We would welcome the opportunity to speak with you about your business goals. Call me directly at 714-719-8966.

To your success!

Patrick Zazueta | Founder
Huntington Coast Capital, Inc.

What Is An Asset Based Loan?

What Is An Asset Based Loan?

Huntington Beach, CA: The term asset based loan is widely used to describe a loan secured against an asset of value as security for the money borrowed. Huntington Coast Capital has been securing asset based loans for our clients in California and across the nation since 2010. Asset based loans consist of loans secured by commercial real estate, inventory, accounts receivable, purchase orders or equipment. Below is a brief summary on how we have assisted our clients in securing asset based loans in California and across the United States in these different categories.

  1. Commercial and investment real estate. Companies that lack sufficient business collateral are often required to pledge outside collateral as an abundance of caution in this type of asset based loan. Often referred to as bridge loans, these loans usually have terms of 6 months to 3 years and are offered through private money capital providers. These asset based loans are offered in California and throughout the country.
  2. Inventory loans. For companies in the manufacturing, distribution, wholesale and retail spaces, inventory represents cash tied up in goods for sale. Inventory can be used as security in an asset based loan. Depending on the type of inventory however, a loan may not be available. For example, if a company is selling fresh fish, meat or poultry, finding an asset based loan will likely not be possible due to the quick turn of this type of product and the potential for spoilage. Other forms of inventory such as t-shirts, tires, dried goods and other products with long shelf lives have a much better chance of being accepted as collateral for an asset based loan.
  3. Accounts receivable and purchase orders. These two assets represent an amount owed and an order for shipment. Both of these asset types qualify for an asset based loan. In fact, these two asset classes are the most popular asset based loan being requested from our clients in California. Companies in search of improved working capital utilize their accounts receivable as collateral for an asset based loan and their purchase orders as collateral when looking to obtain funding to cover their cost of goods to suppliers.
  4. Equipment loans. Asset based loans used to purchase or refinance equipment are for a specific purpose. Retail sector companies such as restaurants are big users of equipment loans as well as companies in the manufacturing sector. Often times in business acquisitions, equipment loans provide a portion of the funds required for the purchase if the equipment is currently owed free and clear and has a usable life of over 10 years.

Asset based loans are vital to the economy and provide funds to companies when more traditional finance programs can not meet the need. If you are a California company in search of an asset based loan or are located anywhere in the continental United States and looking for financing to take advantage of growth opportunities, consider an asset based loan.

Need assistance navigating the capital markets? That is our specialty and we are eager to help. For advise and counsel on asset based loans or any other form of business financing, give us a call 714-719-8966.

To your success!

Patrick Zazueta
Huntington Coast Capital, Inc.

How Will A Rise In Interest Rates Effect Business Owners?

How Will A Rise In Interest Rates Effect Business Owners?

Things That Traditionally Increase When the Fed Increases Interest Rates

The recent rise in the Fed funds rate will likely cause a ripple effect on the borrowing costs for consumers and businesses that want to access credit based on the U.S. dollar. That has an impact across numerous credit categories, including the following:

  • The Prime Rate: A hike in the Feds rate immediately fueled a jump in the prime rate, which represents the credit rate that banks extend to their most credit-worthy customers. This rate is the one on which other forms of consumer credit are based, as a higher prime rate means that banks will increase fixed, and variable-rate borrowing costs when assessing risk on less credit-worthy companies and consumers.
  • Credit Card Rates: Working off the prime rate, banks will determine how credit-worthy other individuals are based on their risk profile. Rates will be affected for credit cards and other loans as both require extensive risk-profiling of consumers seeking credit to make purchases. Short-term borrowing will have higher rates than those considered long-term.
  • Savings: Money market and credit-deposit (CD) rates increase due to the tick up of the prime rate. In theory, that should boost savings among consumers and businesses as they can generate a higher return on their savings. However, it is possible that anyone with a debt burden would seek to pay off their financial obligations to offset higher variable rates tied to credit cards, home loans, or other debt instruments.
  • U.S. National Debt: A hike in interest rates boosts the borrowing costs for the U.S. government and fuel an increase in the national debt. A report from 2015 by the Congressional Budget Office and Dean Baker, a director at the Center for Economic and Policy Research in Washington, estimates that the U.S. government may end up paying $2.9 trillion more over the next decade due to increases in the interest rate, than it would have if the rates had stayed near zero.

Things That Are Largely Unaffected When the Fed Increases Benchmark Interest Rates

  • Auto Loan Rates: Auto companies have benefited immensely from the Fed’s zero-interest-rate policy, but rising benchmark rates will have an incremental impact. Surprisingly, auto loans have not shifted much since the Federal Reserve’s announcement because they are long-term loans.
  • Mortgage Rates: A sign of a rate hike can send home borrowers rushing to close on a deal for a fixed loan rate on a new home. However, mortgage rates traditionally fluctuate more in tandem with the yield of domestic 10-year Treasury notes, which are largely affected by inflation rates.

Things That Traditionally Decrease When the Fed Increases Interest Rates

  • Business Profits: When interest rates rise, that’s typically good news for the profitability of the banking sector, as noted by investment giant Goldman Sachs. But for the rest of the global business sector, a rate hike carves into profitability. That’s because the cost of capital required to expand goes higher. That could be terrible news for a market that is currently in an earnings recession.
  • Home Sales: Higher interest rates and higher inflation typically cool demand in the housing sector. On a 30-year loan at 4.0%, home buyers can currently anticipate at least 60% in interest payments over the duration of their investment. Any uptick is surely a deterrent to acquiring the long-term investment former President George Bush once described as central to “The American Dream.”
  • Consumer Spending: A rise in borrowing costs traditionally weighs on consumer spending. Both higher credit card rates and higher savings rates due to better bank rates provide fuel a downturn in consumer impulse purchasing. (For more, read How Interest Rates Affect Spending.)