After keeping rates at historic lows for several years, the Federal Reserve launched a series of upward adjustments over the past 12 months, including an increase last month. Many analysts believe there is a general expectation that rates are likely to continue rising in the years ahead and some have even predicted four increases in 2018*.
How Rising Rates Affect Business Decisions
One area most heavily impacted by the interest rate environment is capital investments. When it comes to the economy, there are a lot of things up in the air, but interest rate risk doesn't have to be one of them. Here are three strategies for eliminating interest rate risk:
1. Take on fixed-rate debt
If interest rates continue to rise, companies that borrow money through debt products may benefit from fixing their debt cost rather than having it float with the current rate in a variable-rate product.
2. Lock in rates now.
If a business knows it will need to make a large purchase in the next 12 months, the business can lock in today's rates for tomorrow's capital purchase. This affords protection against future rate increases, albeit at a premium cost.
3. Look for a true lease i.e., a Fair Market Value lease, or FMV lease) rather than a finance lease (i.e., a Dollar Buyout lease).
As interest rates rise, so does the cost of capital. It may be more advantageous for a business to rent rather than buy equipment, paying for use instead of paying for ownership.
The uncertainty around interest rates makes selecting the right financing strategy even more important. And yet, one thing remains clear: the right products and borrowing structures exist to help businesses meet their long-term finance needs while managing a complex and evolving interest rate environment.