With short-term interest rates up, now's the time to trim financing costs by cutting back on adjustable-rate loans.

Rising interest rates By Crystal Detamore-Rodman

Like any business owner, Jeff Samuelson never has cash flow far from his thoughts. "We want to be more liquid so we can be nimble in making decisions," says the owner of Samuelson True Value Hardware and Lumber in Craig, Colorado.

Until recently, though, that was difficult because the business's cash flow was being squeezed by a hodgepodge of short-term, variable-rate loans-12 in all. Samuelson knew that consolidating those credit products would help reduce financing costs. And with interest rates rising, the time had come to make the switch to fixed-rate financing. "We knew that if we didn't lock in the adjustable-rate loans, the interest rates would continue [to increase]," recalls Samuelson, 40, who owns and operates the $8.5 million business with his brother, Mark.

By refinancing, the company saw its interest rate decrease to 6.78 percent from an average rate of 7.8 percent, and it is now realizing a monthly cash-flow savings of $8,000. "When you're talking about loan amounts [of this size]," says Jeff, "a point or two can make a big difference."

In for the Long Haul
Interest rates have risen steadily since June 2004 when the Federal Reserve Board raised short-term interest rates for the first time in four years. This has led to a gradual but significant increase in the prime rate, which sets interest rates for floating-rate loans. "When interest rates are falling, a variable-rate loan is the way to go," says John Milbauer, president and CEO of Patriot Bank Minnesota in Lino Lakes, Minnesota. "But in a time of rising interest rates, anyone who has a variable-rate loan should be trying to fix the rate to make sure they have a handle on what their interest costs are going to be over the next several years."

In reality, though, some types of variable-rate credit cannot be converted into long-term, fixed-rate financing. That's because certain assets are simply too short-term in nature. Cases in point: inventory and accounts receivable. "Banks aren't too keen on giving you a long-term loan on an asset that's going to potentially disappear during the term of the loan," says Scott Page, executive vice president of Vectra Bank Colorado in Denver.

As a result, many short-term credit consumers have little choice but to absorb the higher interest costs. However, some entrepreneurs also tap those floating-rate lines of credit to fund lengthier capital commitments like buying equipment-a costly financing strategy in today's interest-rate environment. Fortunately, companies can often transfer those assets to a long-term loan with a fixed, more favorable interest rate.

No Knee-Jerking
Though business owners are understandably anxious about rising interest rates, experts warn that making a strategic decision-such as whether to upgrade an out-dated facility-based only on interest rates can have dire consequences. "If your business is nonproductive due to an obsolete or [undersized] facility, moving to an appropriately sized building to maximize production is always going to be beneficial to the business in the long run," Milbauer advises. "I don't think any business should ever [consider] adding equipment or [make a] decision to grow into a larger facility based on interest rates."

By the same token, commercial borrowers should carefully examine any refinancing deal to determine the actual cost savings. That's because the loan may contain a prepayment penalty clause, which states that if your loan is paid off within a specified period of time-often in the first three years-the lender will charge you a fee.

Experts agree that you're more likely to get a better deal overall if you solicit proposals from several creditors, not just from your regular lender. Jeff Samuelson concurs: "We had gone to a couple of banks and kind of [reached] dead ends. [The banks] may not have understood the loan fully. We had to get the information to the right banker, and once that happened, everything popped for us."

Crystal Detamore-Rodman is a Charlottesville, Virginia, writer who covers the small-business finance market.