WOJTOWICZ: Be careful when locking in low loan rate

August 27, 2010

Q: I see that interest rates for small-business loans are trending lower again. I would like to expand my business and interest rates are a big factor in my plans. Is it possible to lock in low rates now? Is there a downside to doing that?

A: The short answer is: Yes, you can lock in low interest rates for the entire term of your business loan. The longer answer is more complex.

First, loan rates are very low. In fact, major corporate bonds are going at unheard-of low rates as companies finance projects or stock buybacks. For small-business owners such as yourself, this may be a golden opportunity to lock in a low rate to finance your own expansion.

Is there a catch? Perhaps. If your banker values you as a customer and wants to participate in your project, he or she may be inclined to take a fixed-rate deal to their loan committee. But the bank also knows that rates are likely to climb over the life of the loan, and may opt to enter into a rate-swap agreement with another party that will—in effect—help it balance the interest-rate risk of your fixed-rate loan. This other party may be another bank or financial institution.

Your bank is protecting itself and still providing you the benefit of a fixed rate. The obvious upside for you: a low interest rate over the course of the loan.

But there is also a downside. It will be very important for you, as borrower, to adhere to every detail of the loan agreement. If it becomes difficult for you to continue to pay the loan, your lender may be forced to “unwind” the swap agreement, pay a fee to the other party, and add that fee to your loan balance.

So the message is: Be sure you understand all of the provisions of a swap agreement that provides you with a fixed rate. Can you predict that your business will never have a bad year? That a partner will not get sick? Or that you will always be in good health? Are you sure that you will not need to restructure this debt before its maturity?

Not all fixed-rate loans are tied to swap agreements. Check various sources of alternative financing such as those through the U.S. Small Business Administration.

All business financing is a blend of sound planning and optimism. It’s always wise to talk to your lender very candidly about the benefits and the drawbacks of locking in a low interest rate.•


Wojtowicz is president and founder of Cambridge Capital Management, an Indianapolis manager of business-financing programs. She also chairs the National Association of Development Companies, the trade association for companies certified to make loans from the U.S. Small Business Administration’s 504 program. She can be reached at 843-9704.


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