Fixed-Rate vs Variable-Rate Business Loans – What Are the Pros and Cons?
Most business loan come with a fixed interest rate – but that isn’t the only option available.
UK businesses can apply for a vast number of products to finance a new business start-up, expand into new markets or products, or shore up cash flow issues.
How Do Fixed-Rate Business Loans Work?
Fixed rates are the most common option and mean your business takes out a loan knowing exactly what it will cost per month and overall.
Interest rates won’t change during your loan term, regardless of what happens with the Bank of England base rate.
The advantages of fixed-rate business loans are that:
- You can budget for a static monthly repayment.
- Loan charges will not increase if interest rates rise.
- The fixed-rate means you can forecast outgoings over the long term.
There are some drawbacks worth considering.
If the base rate drops, you won’t benefit – your business will still need to keep up with the loan repayments based on the interest rate you agreed to at the start.
Most interest rates quoted on a fixed-rate loan are slightly higher than on a variable-rate product, primarily to protect the lender if the scenario we’ve just mentioned occurs.
How Do Variable-Rate Business Loans Work?
A business loan with a variable rate means that the exact interest you pay will change over time – for example, if the base rate climbs by 0.5%, your interest calculations might increase from 8% to 8.5%.
Benefits of choosing a variable-rate business loan include:
- More competitive interest rates than a fixed-rate product.
- Lower monthly repayments and overall debt if interest rates drop.
The pitfalls are that your lender will automatically increase your repayments if interest rates rise, although they’ll normally give you a little notice beforehand.
Total amounts owing and the instalment values will increase every time interest rates rise.
It can be tricky to budget for a variable-rate loan because it’s impossible to know with certainty what the interest base rate might do in, say, three years – so it’s a gamble, particularly if you don’t have a lot of wiggle room in your cash flow.
Should I Apply for a Fixed-Rate or a Variable-Rate Business Loan?
There isn’t an easy answer because the appropriate loan product and interest basis for your business loan will depend on your company, finance brokers and borrowing requirements.
Fixed-rate loans are normally advisable if:
- The business has a tight cash flow and little contingency to cope with sudden cost increases.
- You prefer to have a static monthly repayment amount that won’t change.
- An increase in monthly payments would threaten the stability of your business.
A fixed-rate loan is the better solution if you’re happy to accept potentially higher interest rates in return for the security and peace of mind that you have budgeted accurately for the repayments.
Variable-rate business loans are suitable if:
- Your priority is finding a loan with the lowest possible interest rate, even if that cost might increase in the future.
- The business has a healthy cash flow and wouldn’t become unstuck if the monthly costs increased along with the base rate.
The biggest question is whether you’re happy to assume the uncertainty that your loan costs might go up – but they might also go down, and you’ll often find among the lowest initial interest costs available.
Over time, most variable-rate business loans end up costing less overall than a fixed-rate loan, but the caveat is that if you don’t have a flexible cash flow, it could be an enormous problem if you can’t keep up with the repayments.
How to Choose a Variable or Fixed-Rate Business Loan From a UK Lender
The first thing to look out for is a legitimate, respected lender, whether they’re a specialist small business financing provider or a well-known bank.
Many businesses focus on interest rates, but there are several other questions you should ask or investigate before you make a financial commitment:
- Is there an application or product fee payable to secure the loan?
- How are the interest rates on the loan product calculated?
- What will the repayments be, and are they monthly or weekly?
- How much is the total repayable over the lifetime of the loan?
- Do you have the option of paying the balance early?
- Are there any additional fees or costs to budget for?
- Will the lender expect a guarantee or security?
It’s important to look carefully at all the terms and conditions before applying.
For example, an early settlement clause could make it impossible to settle your debts early if business performance increases.