If you have outstanding debt on a loan, you may be considering taking advantage of floating interest rates, which are at an all-time low.
While the potential reward is tempting, there is plenty of risk as well, according to Nicholas Browning, president and CEO of FirstMerit Bank’s Akron region.
“The concern is how long those low floating rates will last,” says Browning. “When they go up, there is the potential for them to go up a lot.”
However, if you simply fix the interest rate on your debt, you may be paying much more in exchange for the peace of mind of a fixed rate.
Fortunately, you have more choices than just a floating or fixed rate.
Smart Business spoke to Browning about how to have the best of both worlds when managing interest rate risk.
What are the dangers of interest rate risk in a rising rate environment?
The danger is getting caught when rates go up. If you have debt outstanding with a floating rate and you don’t do anything to fix those rates, you are at risk. When rates go up, you will be paying higher interest costs, which may affect all aspects of your business.
The potential for rates to drastically change is very real. We are now at all-time lows, and if you look back to when rates where close to these levels, you’ll find that they moved a lot in a short period of time.
For example, in 2004, floating rates increased 4 percent in a two-year period. People have a short memory and are surprised by how fast rates can move and how much they can move. The worry is, if you have a certain rate today, can you handle a rise that significant in so short a time? Most people would say no.
What can businesses do to protect themselves from rising rate risk?
The No. 1 solution is an interest rate swap. A swap is a product banks offer clients that allows them to fix rates on all or a portion of their debt.
Traditional fixed-rate loans have no flexibility from an interest rate risk management perspective. The rate is fixed for the entire loan balance. With swaps you have a lot of flexibility; you don’t have to fix the rate of all of the debt. With a swap you can really manage your interest rate risk.