Fixed vs variable rate

When a lender offers a term loan for a business purchase, it may offer both options. BDC describes a fixed interest rate as one that does not change over the term of the financing, and a variable rate as one that can vary over the term. BDC says a variable rate is based on a reference rate, which in most cases is the prime rate plus additional percentage points to cover the lender’s risk.

What BDC says about the two

BDC says fixed rates are almost always higher than floating rates at any given time, though this can vary in more volatile economic environments. It says a fixed-rate loan typically cannot be paid back ahead of schedule without the lender’s permission, while a floating-rate loan can generally be repaid with lump-sum principal payments up to a specific amount without penalty. It also notes that the risk of rate movement on a floating loan is borne by the borrower.

What to ask

• If the rate is variable, how large would a payment become if prime rose, and could the business carry it?
• What prepayment limits and charges apply to each option?
• Can the loan be switched between fixed and variable later, and at what cost?