Why a small increase in US interest rates might not change much for most companies

With a new leader at the Federal Reserve, there is worry that interest rates might increase soon. The decision depends on many things, like inflation, jobs, and the economy's general growth. While the media and politicians might react strongly, a small change in interest rates usually does not have a big impact on most small businesses.

An increase of 0.25% in interest rates does not significantly change how much it costs most established businesses to borrow money. For many, it will make no difference at all.

If the Federal Reserve does raise its main interest rate by this amount, the prime lending rate would likely go up to 7%. Most of my clients, who are small business owners, do not pay this prime rate. They are often seen as riskier investments.

Instead, these businesses usually pay 1% or 2% more than the prime rate. Would this small interest rate rise make them change their plans for investing, borrowing, or hiring? No, it probably won't. For example, a business taking out a $500,000 loan for equipment over five years would see their annual payments increase from about $120,942 to $121,658. Even if the prime rate went up to 8.5%, the annual payment would only become $123,099. This small difference is not enough to stop these clients from moving forward with their financial plans.

The truth is that the financial markets, even for small companies, are quite stable at the moment. Some might think new businesses could face difficulties. However, this really depends on the type of new business. Companies in the technology sector, especially those working with artificial intelligence (AI), are finding it very easy to get funding. Venture capital money for tech companies, and any company mentioning AI, increased by 51% last year, reaching $320 billion. For most small businesses that are not typical targets for venture capital, banks are still willing to lend.

The Small Business Administration has made more credit available to many small companies, particularly manufacturers, and is backing a larger number of bank loans than in previous years. According to the Federal Reserve, the approval rate for small business loans remained steady at about 52% last year, which is up from 46% in 2021. A financial company called Biz2Credit recently reported that the amount of money businesses are repaying in loans increased by 24%, and their ability to manage these payments improved significantly. This suggests that stronger small and medium-sized businesses are better able to handle their regular loan payments.

What about regular people? Their spending is a major driver of growth for small businesses. If people are spending all their available credit, it would affect the whole economy. So far, though, things are looking okay. Consumer spending increased significantly last month, rising faster than inflation. Also, the number of people falling behind on credit card payments and the amount banks have to write off as unpaid debt have been decreasing each quarter since 2024.

A report from a well-known credit scoring agency stated that consumer credit is strong. The data shows that people have mostly adjusted to a period of higher interest rates, even with rising living costs and the restart of student loan payments. This does not mean that businesses and consumers face no financial challenges. With millions of small businesses and hundreds of millions of people in the country, a noticeable number will naturally struggle to get funds or pay their bills.

Jamie Dimon, the CEO of JPMorgan Chase, has expressed concerns that the next economic downturn, where borrowers struggle to repay loans, defaults increase, and lenders become very strict, could be worse than expected. He pointed to the large amount of debt in areas like private credit and high-yield bonds as a potential problem. An overly large interest rate increase could indeed cause issues. However, a typical local company borrowing $500,000 for new equipment is unlikely to base its purchase decision on a small interest rate change.

They will decide based on whether they believe there will be enough customer demand to justify the investment. Another worry is the increase in company bankruptcies in the US. The American Bankruptcy Institute reported that small business bankruptcies rose by 67% last quarter compared to the previous year. This is due to ongoing inflation, high interest rates, and global instability. Some lenders are becoming more cautious about providing loans due to economic uncertainties affecting the US and the world.

However, like Jamie Dimon, the CEOs of Bank of America and Wells Fargo are not yet sounding major alarms. They have reported that while markets can be unpredictable, the underlying economy remains strong, and consumers and businesses they serve are financially healthy. They are monitoring risks, but for now, they see solid customer activity and stable financial health, suggesting a resilient American economy.

So, will the Federal Reserve raise interest rates? Perhaps. But for many established small businesses, a modest increase is unlikely to change their important decisions about investing or hiring.