Interest Rates and Your Small Business

  •    A freelance reporter and writer based in Philadelphia, Pa., Dinah previously worked as a staff reporter for The Associated Press and Dow Jones Newswires.

Speculating about when the Federal Reserve may raise interest rates again is a favorite pastime among market watchers, but what do those moves mean for the mom-and-pop shop, the startup entrepreneur and the sole proprietor?

In the near term, any action the Fed might take is unlikely to make a big difference for very small businesses, even if the cost of a loan becomes a bit more expensive.

"I've never seen anybody put out of business because the interest rates went up one or two points," says Michael Glauser, executive director of the entrepreneurship program at Utah State University.

Glauser, author most recently of Main Street Entrepreneur: Build Your Dream Company Doing What You Love Where You Live, has worked with hundreds of startups and notes that very few receive debt financing of any kind.

The vast majority are bootstrapped, cobbling together resources, relying on free mentors and used equipment. They eventually growing using cash flow, he says. "Entrepreneurs are very resourceful and they figure out how to get things done with less," Glauser says.

This means that, unless your small business is tied closely to the more interest-rate-sensitive housing market, or you rely heavily on a credit line, you probably won't be hit much by a measured boost in interest rates — and the next increase is likely to be small anyway.

Priyanka Prakash, a finance specialist, writer and editor at Fit Small Business, an educational site for entrepreneurs, says a rate increase would probably be offset by more customer demand.

A small rate increase could mean small business owners may see slightly higher monthly payments -- especially those with a variable rate loan -- says Prakash.

"The rate increase usually happens all across the board and affects a wide range of business and consumer loans. For example, last December, when the Fed raised the fed funds rate, Lending Club followed suit by raising rates on new loans by 0.25 percent," she says.

​"Although small business owners may be a bit more cash strapped from higher rates and monthly payments, this will be countered by increasing customer spending. Rising rates reflect more consumer confidence, so as consumers spend more, small businesses will reap the benefit," says Prakash.

The U.S. has added about 500,000 startups, including sole proprietorships, every month since 1997, regardless of what was happening with interest rates, according to author Glauser.

The Wall Street Journal-reported prime rate, recently at a relatively low 3.5 percent, is a benchmark that banks and other lenders use as a basis for pricing interest rates on mortgages, credit-card debt and other loans, notes FedPrimeRate.com.

The prime rate itself is based on a benchmark interest rate set by a Federal Reserve committee, which meets approximately once every six weeks. The prime rate typically sits at three points above the federal benchmark, FedPrimeRate.com notes.

After a rebound in U.S. job growth in June, Federal Reserve policymakers anticipate another rate hike this year, but it's not expected to happen at the committee's July meeting, Reuters reported recently.

Now, if your small business is beyond the startup stage, up and running and using credit, you may be affected by higher interest rates. Companies that must borrow because they need material inventory, for instance, will see higher interest on credit lines, Glauser notes.

Even so, baby steps in Fed rate hikes shouldn't take a big toll for small businesses.

"It costs them a little more to buy and flow inventory … so the price of things go up" as businesses pass along those higher expenses to customers, he says. “Things that are very expensive like houses and cars, those businesses may slow down a little bit" as interest rates rise.

Interest rates are so low now — in the 3 percent to 7 percent range — that a small boost in the Fed rate won't be a big deal, Glauser says.

He adds, "Anything below 8 percent is attractive to the economy."