Canadian businesses are emerging from the dark days of the pandemic ready to grow again. But with the Bank of Canada raising interest rates for a sixth time this year on October 26, many business owners are wondering how they will be affected.
In this article, we break down interest rates, how they affect you and your business, and what you can do now to handle this ever-changing rate environment.
What is interest and how does it affect me?
You can think of interest as the charge your lender applies for the privilege of borrowing money. Interest is expressed as a set percentage of the outstanding amount – also known as the principal – that you owe your lender.
How is my interest rate calculated?
The interest borrowers are charged is usually quoted as the annual percentage rate. The Bank of Canada sets a base rate; other Canadian financial institutions—inluding banks and credit unions—then choose wheather to adjust their rate accordingly. When the Bank of Canada raises or lowers interest rates, so too do the rates offered by Canadian financial institutions. The Bank of Canada periodically raises interest rates to offset inflation, in which prices rise and affordability declines. The Bank of Canada sometimes lowers interest rates, in order to boost lending and economic activity.
It is crucial to understand why interest is charged as a percentage rather than a set amount. If your lender was simply looking to earn money from lending funds, charging a set fee for the service would be appropriate. But the lender also has to consider the likelihood that the funds being borrowed might not be paid back. Therefore the interest rate lenders charge borrowers varies depending on how risky the loan is considered.
How will rising interest rates impact my business?
Though rising interest rates are often seen as damaging to small businesses, the truth is more complicated. New and small businesses alike with variable rate loans will find that rising interest rates can make business planning more difficult. As the cost of maintaining loans increases, profitability may decline. Moreover, rising interest rates will compel businesses to delay growth plans, as borrowing for future expansions becomes more expensive. Business cash flows will be strained as funds are redirected to interest payments. In other words, there will be less money spent on goods and services.
However, rising interest rates also benefit small business owners by incentivizing savings. As rates increase, investments in other areas, including expansions, become less necessary for the long-term profitability of businesses. Savings accounts that offer raised interest rates can become more attractive as investments providing passive – low risk – incomes. For cautious business owners who prefer slow and steady growth, rising interest rates will arrive as a welcome change.
How your business is impacted by rising interest rates depends on a variety of factors, including how you intend on expanding it and what kinds of debt you are servicing. In any case, business owners should be most concerned with obtaining the rates that best match their business’ needs.
How can I get the best rates possible?
There are two broad factors that help to determine the interest rates borrowing businesses can and will receive. The first of these is the borrower’s credit history, while the second is the credit product being used.
Borrowers who have a history of making loan payments in full and on time can expect lower interest rates, because they are considered lower risk. Meanwhile, borrowers who struggle with either may be at a higher risk of default on their loans. In short, they might not pay back their loans at all. These higher risk borrowers, are given higher interest rates as compensation to the lender.
It also matters how funds are being lent to borrowers. Loans come in generally two forms – secured and unsecured – and offer different interest rates.
Unsecured loans are more common, and are often associated with smaller debt products, including low-limit lines of credit and credit cards. They are more flexible, with credit limits that can be increased periodically either by way of pre-approvals or through direct applications. In exchange for this flexibility, however, they tend to charge higher interest rates.
Secured loans typically include products like mortgages, in which borrowers receive loans with lower interest rates that are supported by cash, property, or other goods they own that can be seized by the lender in case the borrower defaults on repayments. What they lack in flexibility, they offer in superior rates and stronger bonds between lender and borrower.
We’re here to help.
It isn’t always easy to understand how rising or falling interest rates will affect your business. And it can feel even more difficult deciding how to adapt to these kinds of changes. The good news is that you aren’t alone.
By speaking with you one on one, our advisors can help you make decisions about your borrowing needs. Connect with a member of our Business Banking Team and we can put a plan together that makes sense for you and your business.
The stuff we have to say.
This article is provided for general information purposes only. It is not to be relied upon as financial, tax, or investment advice or guarantees about the future, nor should it be considered a recommendation to buy or sell. Information contained in this article, including information relating to interest rates, market conditions, tax rules, fees, and other investment factors are subject to change without notice, and Coast Capital Savings Federal Credit Union is not responsible for updating this information. All third-party sources are believed to be accurate and reliable as of the date of publication and Coast Capital Savings Federal Credit Union does not guarantee the accuracy or reliability of such sources. Readers should consult their own professional advisor for specific financial, investment, and/or tax advice tailored to their needs to ensure that individual circumstances are considered properly and action is taken based on the latest available information.