This week, the Federal Reserve Announced Cut the federal funds rate that it charges member banks by 50 basis points (0.5 percentage points). The expected effect would be that banks, with their reduced costs, would be able to charge customers lower interest rates on loans, and the cost of capital would fall, making capital more readily available.
This is good news. But don't get too excited. If you run a small business, this rate cut will have little impact on you.
To put it in perspective, the prime rate that most banks were charging before the Fed cut rates was 8.5 percentThis rate is up from 3.25% in May 2022, meaning that borrowing costs for businesses have nearly tripled in the last 15 months. This is just the prime rate. Very few small businesses have access to this rate. Typically, my clients are paying 1-3 percentage points above this rate, meaning they are paying 9.5-11.5% interest on their loans.
Doing the math, to get a $1 million, five-year equipment loan by May 2022 would cost roughly $139,159 At the time, the average interest rate was 2 percentage points above prime, or 5.25%, for a total interest of 10.5%. Before the Fed's rate cut this week, the same loan would have cost $289,634 If interest rates fall by just 0.5%, the annual interest cost will be $274,822or $14,812 less. This isn't really that much, about $3,000 a year.
Of course, every little bit saved helps, but saving $14,812 over five years is unlikely to make a significant difference to your company's bottom line.
It also likely won't make much difference to the credit teams at most banks who approve these loans. Federal Reserve Bank of Kansas Citynew loans to small and medium-sized enterprises decreased by 6.7% compared to the same period in 2023 and by 6.3% compared to the previous quarter. Reuters reports Earlier this year, “America's small business owners are struggling to access capital from traditional lenders as the effects of rising interest rates and bank failures from a year ago linger and curtail business growth for some.”
That's because one of the biggest factors in assessing creditworthiness is a company's ability to repay its loans. Banks don't like defaults, regardless of the collateral a company can provide. So as borrowing costs rose, many small businesses' ability to repay their newly incurred debt became a risk, and banks approved fewer loans.
Using the example above, a $1 million equipment loan would increase a small business' monthly loan payment from $18,985 in 2022 to $21,493 in 2024. A half-percentage point decrease in interest rates would reduce the monthly loan payment by about $250 to $21,247. Unless you have a project with an absolute high return on investment (secured), I don't think this rate decrease would significantly change the bank's decision.
Wall Street has been expecting rates to fall for weeks, which is why the market didn't react much when the Fed announced it: the decision was already priced in. The same can be said for mortgage rates.
At the time of writing, mortgage interest rates are 5.6 percent. Even if interest rates were to fall by a half-point (which I don't expect, since these rates also anticipate Fed action), I'm not sure it would make much of a difference for homebuyers. Still, the reality remains that most homeowners are locked into mortgage rates that are nearly half what they are today. Selling a home to take out a double mortgage seems like a long shot, especially at a time when so many other costs of living are rising. Dramatically increased Over the past few years, it seems like it's not something most people are willing to do.
That means we are still waiting for a long-awaited recovery in residential real estate.
I write about this because the residential real estate industry has far-reaching effects on businesses large and small across the country. In addition to the businesses that directly profit from real estate transactions (brokers, title agents, home inspectors, lawyers, etc.), there are many businesses that benefit from new business as people renovate, landscape, repair, buy furniture, move furniture, and do all the other things to get settled. These businesses will also have to wait for the economy to recover.
So what is the tipping point?
To see a real impact, business rates, especially the prime rate, would need to fall to around 6% and mortgage rates to fall to 5% or less, perhaps closer to 4%. That would still be higher than rates before 2022, but if those rates were to fall, Unreasonably low For an unreasonably long period of time. To achieve this, the Fed would need to cut the federal funds rate by at least 1 percentage point. So there is still a long way to go.
But we are moving in the right direction. And News coverageMore rate cuts are on the way, and in the meantime, businesses shouldn't get too excited about the Fed's decision.
Gene Marks is the founder of The Marks Group, a small business consulting firm.
