This week, the Federal Reserve announced a cut of 50 basis points (or half a percentage point) in the federal funds rate, which is the rate it charges its member banks. The expected effect will be that banks, with their costs lowered, will lower the interest rate they charge customers on their loans, thereby making capital less expensive and more readily available.
It is good news. But let's not get too excited. If you're running a small business, this cut in interest rates will have little impact.
To put things in context, the prime rate charged by most banks before the Fed rate cut has been 8.5 percent. That rate rose from 3.25 percent in May 2022, which means that the cost of borrowing almost tripled for businesses during that 15-month period. And that's just the prime rate. Few small businesses are have access to this rate. Usually, my clients pay anywhere from 1 to 3 points above this rate, so they are paying 9.5 to 11.5 percent interest on their loans.
To do the math, before May 2022, a five-year equipment loan for $1 million would require approximately $139,159 in total interest at an average interest rate of 2 points above prime at the time, or 5.25 percent. Before the Fed’s rate cut this week, that same loan at 10.5 percent (2 points above prime) would require $289,634........