Inflation happens when prices rise, which means the purchasing power of your dollar falls. Although that sounds bad, most economists agree that a moderate inflation rate is necessary for a healthy economy, because it encourages people to spend and invest their money rather than parking it in a savings account.
So, what does inflation mean for an equipment loan? In general, how inflation affects your equipment financing will depend on two factors: what inflation is doing (the inflation rate) and whether your loan has a fixed or variable interest rate.
Understanding Fixed Interest Rates
When you have a fixed-rate loan, you pay the same amount each period throughout the life of the loan, regardless of the inflation rate. The other option is a variable-rate loan, which has an interest rate that will move up or down based on changes in the market or fluctuations in the prime rate, which is a guiding interest rate that banks use. (The prime rate is partially based on the federal funds rate, set by the Federal Reserve.)
The predictability of fixed-rate loans is generally a good thing, especially in the world of commercial equipment financing. Most business owners know how much money they need, what equipment they need, and for how long they need it. Fixed interest rates are usually better for these borrowers since a fixed rate lets them accurately predict how much they’ll have to pay each period and how much the financing will cost over the life of the loan.
Because of this predictability, we’ve said in the past that fixed-rate financing is most often the best option for business owners who need to finance an equipment purchase. But with all the financial instability resulting from the COVID-19 pandemic, is that preferred status still deserved?
The Good and the Bad of Fixed Interest Rates
When the rate of inflation goes up, the fixed-interest rate financing you took out costs you less than when you took out the loan since the dollar has lost some of its value. You’re essentially paying the lender back money that’s worth less than what it was when you took out the loan.
Not only that, but wages and revenues tend to rise during periods of high inflation. So, if you’re making more money but your monthly payments for your financing stay the same, then the payments take up a smaller percentage of your working capital.
On the other hand, the opposite is true: when inflation rates go down, your fixed-rate loan stays the same, but interest rates will generally go down. When this happens, the rate on your fixed-rate loan or lease may not look as favorable as it did when you secured the financing.
RELATED: Understanding Interest: Variable vs. Fixed Interest Rates for Equipment Financing
Is a Fixed Rate Still the Best Choice for Equipment Financing?
In general, the COVID-19 pandemic hasn’t changed our view that fixed-rate financing is the preferred method for borrowers utilizing equipment financing. While it’s possible that a period of low interest rates might take some of the shine off your fixed rate, you can also benefit if interest rates are high. Meanwhile, you get the peace of mind and planning ability that comes with knowing the exact amount of your monthly payments as well as how much your financing will cost you over the life of the loan.
Also, it’s usually not a good idea to base your financing decisions on inflation rates since future rates of inflation are hard to predict. Experts haven’t even come to a consensus yet on how the pandemic has affected inflation. The most recent government statistics say prices have risen by only 1 percent in the past year, but many economic analysts say that figure doesn’t accurately capture the cost of living during the pandemic, which may be rising much faster.
Even though we recommend fixed-rate loans to meet the needs of most of our clients, that doesn’t mean variable-rate loans don’t have their uses. The best way to figure out what makes sense for your business is to get in touch with a commercial financing expert who can learn about your unique situation and deliver a personalized recommendation.
Team Financial Group Offers A Variety of Equipment Financing Options to Fit Your Needs
At Team Financial Group, we offer leases and finance agreements that we can customize to fit your unique business needs. We’re dedicated to helping our clients grow and thrive by providing efficient and flexible financing options and personalized service.
Ready to get started? Applying is easy! Just visit our application page, fill out your contact information, and one of our commercial financing experts will get in touch to help walk you through the application process and determine which option is right for you. If you still have questions and you need answers before you’re ready to apply, you can use our online contact form to get in touch.
Reference
Wolfers, J. (2020, September 2). Inflation is higher than the numbers say. The New York Times. Retrieved from https://www.nytimes.com/2020/09/02/business/inflation-worse-pandemic-coronavirus.html
The content provided here is for informational purposes only. For financial advice, please contact our commercial financing experts.