Variable Rate Business Loans
When applying for a business loan you'll have to make a choice: Should you opt for a fixed or variable interest rate? Here's what you need to know.
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One of the most important factors for a business loan is the interest rate you will be charged since it determines the cost of the loan and how flexible it is. Business loans don't only come with different rates of interest, but they also come with different types of interest.
Some business loans will maintain the same interest rate for the life of the loan (fixed rate business loans) while the interest rate on other business loans will change over time (variable rate business loans). Which is the better option, and why would a business choose one over the other? Read on to find out.
Variable rate business loans you can apply now
What you need to know about business loan interest rates
Before we get into the details about variable rate business loans, let's cover some loan basics. When you borrow money, you will repay the total amount of the loan (the principal) in regular installments over a set period of time (the loan term). The lender will also charge interest on the loan, calculated as a percentage of the principal.
This interest rate will depend on a number of factors, including the amount of the loan, whether the business loan is secured by an asset, and whether the loan is considered high or low risk. Interest rates can vary considerably from one lender to the next, making it important to compare your business loan options to make sure you're getting the best deal.
How does a variable rate business loan differ to a fixed rate?
A variable interest rate will change over time, rising or falling in line with the movements of the financial market and the official cash rate set by the Reserve Bank of Australia (RBA). As the interest rate changes, the amount of interest payable on the loan will change. A fixed rate, as the name suggests, is a set interest rate that remains constant over the life of the loan.
With business loans, a fixed rate business loan will be charged the same amount of interest with each repayment. This means that the repayment amount – made up of the principal and interest – will remain constant. A variable rate business loan will incur different amounts of interest as interest rates change over time. While the principal repayments will usually stay the same, the interest component of the repayments could change from one repayment to the next.
When to consider a variable rate loan
There are a number of situations when a variable rate business loan may be a better choice:
A variable rate business loan would suit a business that does not need to strictly budget for its loan repayments. This would typically be a business with a healthy enough cash flow that it will not experience financial stress as a result of the ongoing loan repayments or financial stress if the repayments were to increase in the future.
The payments on a fixed rate business loan can never increase and act as a type of insurance against rising interest rates. A variable rate business loan would, therefore, suit a business that is willing to bet that interest rates and the RBA's cash rate will be more likely to go down (or at least stay the same) rather than increase. A business confident that interest rates are likely to drop may be more inclined to choose a variable rate business loan rather than locking in a higher rate.
A fixed rate business loan tends to be relatively inflexible when it comes to varying the terms of the loan, including making additional repayments, redrawing equity in the loan and early payout without penalty. A business may choose to opt for a variable rate loan to access greater flexibility in the loan terms at the expense of having to deal with a lack of repayment certainty.
Questions to ask before you apply for a variable rate business loan
Before applying for a variable rate business loan, consider the following questions:
- What is the market likely to do in the short- and mid-term? While no one can predict the movements of interest rates and the cash rate with absolute certainty, savvy investors can look at indicators and make general predictions about the likely movements of the market.
- What is the difference between the current interest rate and the fixed rate on offer? Fixed interest rates tend to be at least a few points higher than the current variable rate.
- How flexible are the loan conditions? Variable rate business loans tend to offer more flexible loan conditions than fixed rate alternatives. Look at the possibility of making extra loan repayments without penalty, having access to an offset account, redrawing equity in the loan as needed and potentially paying out the loan early without penalty.
How to compare variable rate business loans
With so much to consider, what should you concentrate on when comparing variable rate business loans? What makes one loan a "better" choice over another? As with any financial product, there is no single business loan that outperforms the rest. The ideal business loan for you will depend on your circumstances and could be very different from the "best" loan for another business.
When comparing variable rate business loans, consider the following:
- Interest rates. Not only is the distinction between a fixed and variable interest rate important, but the rate itself should be considered.
- Fees and charges. A lower interest rate may not end up being such a good deal when a high monthly fee is charged. Look for business loans with low or no ongoing fees, and be mindful of establishment and early payout fees.
- Security. Does the loan require an asset as collateral? If you have a suitable asset – particularly residential property – you could receive an interest rate discount and other favourable terms.
- Loan term and repayments. Look for a loan term that suits the purpose of the loan. If the loan is to buy stock that will last for a year, you won't want to be still paying it off in three years' time. Also look for loan repayments that match your cash flow.
Have more questions about variable rate business loans?
What is a split interest rate?
A split loan is one that is divided into two parts – one part is subject to a fixed interest rate, and the other part is charged at the variable interest rate. A common choice for individuals and businesses that want the certainty of a fixed rate but the flexibility of a variable rate, a split loan combines the best features of each loan. Loans can be split evenly or weighted one way or the other, such as a 60% fixed and 40% variable loan.
Can I turn a fixed rate business loan into a variable rate loan?
Some lenders allow a fixed rate contract to be broken and the loan converted into a variable rate loan, but it will come at a cost. If you're in this situation, read through your loan documents carefully and discuss the situation with your lender to find out your options. An alternative could be to refinance your loan with another lender, effectively paying out the remainder of your current fixed rate loan (along with all applicable penalties) and taking out a new, variable rate business loan with a different lender.
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