Fixed or Variable Loan-header

Do you have brilliant business-expanding ideas that you're still trying to figure out how to pay for? Or maybe you just need to smooth out your access to working capital in order to finish 2017 operations strong. 

This is the time of year for big thinking and big planning and, for some, big questions about how to fund those visions. Choosing the right loan is the first step. 

“Both fixed and variable rate loans can be valuable. It all depends on your company, your goals and the rate environment at the time you take out the loan," said David Cameron, Head of Business Banking at City National Bank. 

When comparing options for fixed-rate or variable-rate loans, here are some things to keep in mind:

1. Fixed Rate

With this loan, the interest rate is fixed using a market rate plus a spread determined when the loan is made. On the plus side, your payments are predictable. If rates are low, you can lock in an interest rate you're comfortable with. On the down side, there's usually a penalty for paying back the loan early. If you're using a loan to buy assets that you don't plan to hold long-term, take that into account before committing to a loan with a prepayment penalty.

2. Variable Rate

A variable interest-rate loan is tied to an index, plus a spread determined at the time the loan is made. That means payments will vary as the index moves up or down. Variable-rate loans typically have lower rates at first, but there can be more risk involved because the payments are less predictable and the interest rate could increase. There are typically minimal or no prepayment penalties with variable-rate loans, but they are subject to minimum floor rates. 

3. Swaps

Without getting too technical, a swap is a way to hedge interest rate risk. It usually involves an exchange of cash flows that effectively converts a variable-rate loan to a fixed-rate loan. If interest rates go up, that swap becomes an asset to you because the bank will pay you to prepay that loan. If interest rates go down, there will be a prepayment penalty. 

“A swap is beneficial in rate environments like today's, where we have historically low rates that are expected to rise in 2017," according to Cameron. Your banker can help you evaluate each option.

4. Caps

If you prefer a variable-rate loan but want to minimize risk, you can choose to purchase a cap. A cap is a product that caps your variable rate at a certain maximum rate that it will never exceed. Your banker will help you compare the fees involved in a cap to the potential costs of a rising interest rate without a cap, to see if it's a good choice for you. 

5. Mix and Match

Another option is to fix a portion of the loan and let the other portion be a variable rate. This can be a good option if you know that you'll have the money to prepay some of the loan, but not all. The portion you expect to prepay can be set with a variable rate that carries low or no prepayment penalties, while the remaining portion will be at a fixed interest rate. 

Julie Larry, owner and president of Antelope Valley-based L&S Construction, obtained two variable rate SBA 7(a) loans totaling roughly $45,000. She used the money as working capital and to purchase new equipment so she could diversify her company's services. Her loan payments adjust every quarter, but she said the adjustments have been small and manageable. 

Over the years Larry has received help and advice from the Small Business Development Center, an SBA service that provides free one-on-one business development consulting to small businesses and entrepreneurs. 

“It's a challenge to have an objective view of your own company, so it can be helpful to have an outside resource to work with," said Catherine Grooms, director of the SBDC based at the College of the Canyons in Santa Clarita, Calif. “It allows you to breathe, to think things through, so you know you're making the right decision for the business."

SBA-backed loans are made by authorized commercial lenders who set payment plans, interest rates and loan terms. Several SBA loan programs are offered for different circumstances and types of borrowers. They include various requirements for participants. City National Bank is a Preferred SBA lender.

All loans, lines of credit and other credit facilities offered by City National Bank are subject to credit approval and additional terms, conditions and eligibility requirements.
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