How Does Inflation Impact Small Business Administration (SBA) Loans?
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The past year has brought on a unique set of challenges for small business owners as the world reacts to the tragedy in Ukraine and works to find a new normal as the crisis of the pandemic lessons. As entrepreneurs navigate unchartered waters, the effects of inflation remain a major concern for small businesses. The U.S. Central Bank, or Federal Reserve, continues to raise interest rates and employees are demanding more money, remote work, and flexible schedules. The inflation rate is at alarming highs and beginning to directly impact the number of Small Business Administration (SBA) loan applications. Continue reading to learn how your small business may be affected.
What’s causing inflation?
Inflation occurs when the cost of products and services increases. Raising prices creates a decrease in the purchasing power of consumers, and ultimately the value of a dollar. As of July 31, 2022, the inflation rate is 8.5%, which is the highest it has been since the end of 1981. In the last year, between July 2021 and July 2022, prices have increased 9.1% overall. These record-breaking inflation rates are being driven by two factors: demand and cost.
Demand-driven inflation, also called demand-pull, describes the effect on the economy when the consumer needs and wants surpass supply. Because of the increase in demand, manufacturers struggle to have the time, raw materials, or manpower to keep up with orders. Businesses selling goods and services are forced to raise prices to control inventory, which alerts consumers that inflation is rising. Consumers become concerned that prices will continue to rise and increase their purchasing to avoid higher costs in the future, significantly impacting demand-pull inflation.
Cost-driven inflation, or cost-pull, happens when businesses raise prices because of a supply shortage. The cost of supplies and raw materials increases to combat the shortages, resulting in higher prices for small business owners. Cost-pull inflation is generally a result of one or more of the following factors:
How small business owners are dealing with inflation
The economic trend on Main Street continues to present financial challenges to small business owners. The U.S. Chamber of Commerce stated that 88% of small business owners currently rate inflation as their top concern. Forecasters there also predict that the number of small business owners affected by inflation will only increase in the last quarter of 2022. In short, the amount of capital required to react to rising interest rates, increasing wages, and supply chain issues is putting an unmanageable strain on entrepreneurs everywhere. Here’s how they’re coping with these inflation-related issues:
- Closing their doors
- Passing price increases on to customers
- Relying on business credit cards
- Taking out small business loans to supplement cash flow
How inflation affects SBA loans
SBA loans are small business loan programs designed to help entrepreneurs that have 500 or fewer employees and operate a nonprofit or for-profit business in the United States. The loans are issued by traditional lenders, like banks and credit unions, and alternative lenders, like Biz2Credit. Up to 85% of each loan is guaranteed by the U.S. Small Business Administration. Each loan program backed by the SBA has its own set of approval requirements, repayment terms, maximum loan amount, and use of funds stipulations. Typically, small business owners prefer SBA loans over other types of loans because they offer lower interest rates and down payments than bank loans, term loans, or lines of credit.
However, with high inflation rates at 8.5%, many aspects of SBA lending for small business owners are being affected including the availability of the loans, the interest rates, and the application requests.
The SBA works with lenders to offer small business owners multiple loan options so that they can match their business needs to the right repayment terms. Some popular SBA loan programs that are available to help small business owners deal with the impact of inflation include:
- SBA 7(a) loan program – up to $5 million in funds designed to help for-profit small businesses in the United States increase working capital, refinance other business debts, or make large purchases, like equipment or real estate.
- SBA Microloans – up to $50,000 for approved borrowers with for-profit small businesses or not-for-profit childcare centers to help with startup and expansion costs.
- SBA 504 loans – long-term financing option that provides up to $5 million for approved borrowers to help cover the expenses of fixed assets.
There are also temporary SBA loan programs that are available for a short period of time to help the economy when needed, like in the COVID-19 relief efforts. Some of those financing options include:
- EIDL loans – Economic injury disaster loans (EIDL) were available through applications submitted by January 1, 2022, to help small business owners recover from the impact of the pandemic through EIDL loans and EIDL advance funds.
- PPP loans – The paycheck protection program (PPP) was created to help business owners pay and retain staff during the pandemic. The PPP loan program ended on May 31, 2021.
As interest rate hikes affect business financing everywhere, SBA loans are not exempt. Factors that affect the SBA loan interest rates include the specific loan program, the loan amount, and the term, or length, of the loan. The interest rates offered by the SBA may be variable or fixed, but most are linked to the U.S. Treasury prime rate. As the inflation rate increases, the Fed increases interest rates in an attempt to help the economy recover, so SBA interest rates have risen over the last year. As of July 2022, the SBA loan rates estimated by Forbes are as follows:
- SBA 7(a) – 7 – 9.5% (variable interest rates); 9.75 – 12.75% (fixed rates)
- SBA Microloan – 6 – 9%
- SBA 504 – 4.9 – 5.2%
- EIDL – 2.75 -3.75%
While each of the SBA loan programs has a predetermined maximum loan amount, the trend in the amount of funds applied for has increased as a response to inflationary costs. Small business owners are combatting the impact of inflation by borrowing higher amounts of money to cover increasing operating expenses like payroll, mortgages, inventory costs, and utility expenses. According to the SBA datasets, average loan amounts have increased steadily since 2017, with small business owners in the travel industry seeking the highest increases.
Tips for finding a loan to cope with inflation
Inflation is affecting small business owners’ bottom lines by impacting the cost of materials, inventory, and supplies, increasing wages, and rising interest rates. Considering your financing options may be a great way to compensate or prepare for decreasing revenues and unpredictable cash flows. There are steps you can start taking today to increase your approval odds for a small business loan, either through an SBA loan program or alternative financing option.
Review your financial statements
Many business owners have experienced a decrease in revenue over the last two and a half years because of the pandemic. Now with inflation pushing prices, interest rates, and wages to all-time highs, entrepreneurs are taking a hit on their profit margins. Loan providers will likely require income statements, bank statements, and income tax returns when underwriting a loan. Some important figures banks and alternative lenders may review are:
- Net income – found on monthly income statements and used to calculate how much profit a business is making after all expenses are covered
- Financing costs – allows lenders to take a quick look at interest expenses and other monthly costs associated with borrowed funds.
- Annual revenues – the amount of money a business earns over the span of one year
- Average daily cash balance – lenders and underwriters may review monthly statements for the business checking account to determine the average cash balance of the business.
Monitor credit scores
Even as interest rates and supply costs increase, it is important to pay bills on time and monitor your personal and business credit scores. Credit scores are evaluated when underwriters are approving or denying loan applications, so higher credit scores will increase your chances of getting a small business loan and may make you eligible for lower interest rates, smaller down payments, and unsecured lines of credit.
Personal credit scores, also called FICO scores, are used by lenders to determine the creditworthiness of a borrower. The score is computed to evaluate the lender’s risk using several factors including age of trade lines, presence of derogatory trade line information, current level of indebtedness, types of credit available (revolving vs. installment), amount of time credit has been in use, and credit inquiries. A credit score above 670 is considered good credit and will benefit the borrower when reviewing loan options. If you don’t know your credit score, you can obtain one free credit report per year here.
Business credit scores are determined using the same factors as the personal credit score, but consider the business’s income, debt, on-time payments, and bad debts. New businesses and startup entrepreneurs may find that they do not have sufficient business credit history for it to be used in determining loan eligibility, but in those cases, lenders will refer to the personal credit score of the business owners. To learn more about business credit scores, check out Experian.com.
Consult the right lender
Whether an SBA loan, term loan, business line of credit or other loan option is right for your business, working with the right lender is the key to a smooth transaction. Depending on the amount of loan you are seeking, your creditworthiness, and the type of loan that will meet your business needs, either a traditional or alternative lender may be the right match for you.
Traditional banks and credit unions work with small businesses to provide different loan options. They are typically found through a referral or asking about funding options at the bank where your personal bank account is held. Traditional banks often offer brick-and-mortar locations and are a great match for small business owners that prefer in-person appointments, can afford to wait on a lengthier approval process, and know which type of loan is best for their circumstances.
Alternative lenders, or online lenders, are another great source for small business financing. Alternative lenders, like Biz2Credit, have access to several different loan options so they’re a great place to start for small business owners. Additionally, alternative lenders offer an online application process and fast funding times. If your small business needs working capital or a large purchase quickly, working with an alternative lender is probably the right choice for you.
The National Federation of Independent Business (NFIB) continues to report that small business owners are becoming less and less optimistic about the effects of inflation on their entities. Entrepreneurs are reacting by closing their doors, relying on business credit cards, increasing their prices, and taking out loans. While SBA loan programs have also been impacted by inflation, they continue to be one of the most beneficial financing options for small businesses. Many business owners, like New York entrepreneur, Shihan Troy Binns, have found relief from working capital concerns after turning to Biz2Credit to explore loan options.