The COVID-19 pandemic has devastated the global economy in a number of ways. Unemployment is up, the stock market is down, and small businesses are struggling to make ends meet. While Congress approved some financial help for small businesses with the Paycheck Protection Program (PPP), that aid has since expired and efforts to extend or renew the program have stalled.
While startups and small businesses wait for help from Congress that may not come, they should look to the actions of another arm of the government for help. In March, the Federal Reserve cut interest rates dramatically. The Fed does this to spur economic growth and investment, as the federal funds rate impacts the interest rate for all kinds of borrowing, including for business loans. Interest rates remain quite low six months later as the economy continues to struggle.
For businesses in need of an infusion of capital, that’s good news. But the low federal funds rate doesn’t have the same impact on all types of business loans. What kind of loans are more affordable during the pandemic? What loans should you avoid? Here, we’ll answer those questions and more.
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What is the Federal Interest Rate?
The federal funds rate is the interest rate that banks and other depository institutions charge to lend money to each other, typically on an overnight basis. The Federal Reserve—the nation’s central bank—dictates the interest rate to control how much of their customers’ money banks have on reserve. By controlling interest rates, the Fed creates some balance in the amount that banks lend and borrow from one another, which helps promote economic stability.
Essentially, when the Fed raises interest rates, it makes it more expensive to borrow, and when it lowers them, it’s cheaper to borrow. When it’s more expensive to borrow, there is a lower supply of available money, which increases short-term interest rates and keeps inflation in check. When it’s less expensive to borrow, there is more available money and it’s easier for businesses to obtain the funds to sustain themselves, if needed, and grow.
Because of its influence on economic action, the federal funds rate is one of the strongest indicators of economic health in the world. Banks often set their own prime rates based on the federal funds rate, which is why federal interest rates are so important during the pandemic.
As of this writing, the federal funds rate sits at a miniscule 0.25 percent, which is down from 2.25 percent a year ago. A dip of 2 percent in just a year is significant and illustrates the impact the pandemic has had on the economy. It also means that borrowing may be cheaper for businesses.
SBA loan rates
One major way that the federal funds rate impacts lending is through the Small Business Administration (SBA). The SBA has a slew of loan products designed specifically for small businesses. The SBA structures loans by providing a government guarantee of up to 85 percent of the amount of loans made by commercial lenders, which encourages lending to smaller, “riskier” businesses.
Right now, SBA loan rates are comparatively low:
- 7(a) loan interest rates: 5.50 percent to 9.75 percent
- CDC 504 loans: 2.28 percent to 2.83
- Max rates for disaster loans: 4.00 percent with no credit available elsewhere, or 8.00 percent with credit available elsewhere
The 7(a) loan is the SBA’s most common loan product and its interest rates break down like this:
- Up to $25,000: 8.00 percent
- $25,000 to $50,000: 6.50 percent for less than seven-year repayment period, 7.00 percent for longer than seven years
- $50,000 or more: 5.50 percent for less than seven-year repayment period, 6.00 percent for longer than seven years
If your business needs money fast, you can apply for an SBA Express loan, which carries a maximum rate of 9.75 percent for a loan of less than $50,000. Loans above $50,000 carry a 7.75 percent interest rate.
While these interest rates are significantly higher than the rates offered by the PPP, they are still some of the best available on the open market and easily the best choice for eligible small businesses.
SBA loan eligibility and terms
Most for-profit businesses are eligible for SBA 7(a) business loans. Generally speaking, to qualify for a loan, you must meet these requirements:
- Own a business that is at least two years old.
- Have a fair credit score.
- Have strong cash flow and debt-to-income ratio.
Most SBA loans have a maximum borrowing limit of $5 million, while SBA Express Loans max out at $350,000. The maximum term length for most loans is 10 years, although for real estate business loans, the maximum length is 25 years. Because SBA loans are comparatively long-term and low-interest, they also charge a guarantee fee of 0 percent to 3.75 percent and may charge a prepayment penalty depending on your agreement.
Economic Injury Disaster Loans (EIDL)
For businesses that are truly at risk of going under immediately and have not already received a PPP loan, there is one SBA program that bests all other available options.
Economic Injury Disaster Loans (EIDLs) offer a flat 3.75 percent interest rate for for-profit small business loans, and a 2.75 percent interest rate for non-profits. Keep in mind: EIDL interest rates are not impacted by the federal rates. These loans also offer extremely generous repayment terms, with a maximum of 30-year loan period, and a deferment of the first payment for a full year.
The SBA has declared COVID-19 a disaster in all 50 states, Washington D.C., and all territories, so any American business meets the first criterion to apply for an EIDL. Otherwise, you’ll need to prove that your business is truly at-risk due to the pandemic. Here’s a checklist of all the documents you’ll need when you fill out your application.
Traditional bank interest rates
The SBA makes it easier for business owners to qualify for loans. If you have strong credit, a positive loan history, and can make a good case as to why a bank should grant you a loan, you’re best off going directly to the bank.
Partially motivated by the low federal funds rate, conventional bank interest rates are quite low right now. Of course, they vary considerably between banks, so be sure to do your research before applying for a loan.
These are the current interest rates, according to Value Penguin:
- Large National Banks: 2.55 percent to 5.14 percent
- Small National and Regional Banks: 2.48 percent to 5.40 percent
- Foreign Banks (with U.S. branches): 1.45 percent to 5.66 percent
These rates are effective annual interest rates (AIR), not annual percentage rates (APR), so they do not include additional fees like closing, origination or other charges that will increase the cost of the loan.
Still, if your business is in good standing, and you have a strong credit history as a business owner, traditional banking is a great option for a business loan right now.
Online interest rates
Online lenders have fewer eligibility requirements and fast underwriting processes, so businesses can get approved and get their money very quickly. On the other hand, online lender interest rates tend to be sky high.
Short-term loans from online lenders offer a huge range of interest rates, ranging from 10 percent to 80 percent APR.
Generally, online lenders trade convenience for high interest rates. But if you’re a new business that got blindsided by the pandemic, online lenders may be your best option as some may only require six months in business to qualify for a loan.
Online lenders are the best choice for businesses or borrowers that are unbankable, like low revenue businesses, applicants with low credit scores, or fledgling startups with no other financing options available.
Credit card interest rates
When in doubt, you can always use business credit cards to borrow money. The best part of business credit cards is that the interest rates don’t matter if you pay your full statement balance on time every month. Of course, that’s not always possible, so it’s worth knowing that credit card interest rates are decent, but certainly not the best available.
Credit card interest rates are also impacted by federal interest rates, so they are subject to change based on Fed actions. According to WalletHub, the average business credit card has an APR of 16.83 percent to 18.13 percent right now. The average store credit card has an APR of 23.93 percent to 25.44 percent.
Again, if you pay your statement on time, you won’t have to worry about interest payments. But if your business is struggling to pay debts, credit card interest rates have the potential to be catastrophically expensive.
The bottom line
Put simply, business loans are more affordable now due to the pandemic, but that’s not a hard and fast rule. The low federal interest rate has made conventional bank loans less expensive, but interest rates and loan terms vary greatly from bank to bank. SBA loan products remain good options for businesses with less than perfect credit, while online loan products are still more expensive and should only be pursued when you’ve explored other options.