Consider Making a Part of Your Business Debt Variable

When a business goes out and borrows money for equipment and expansion the most common form of borrowing I see is fixing the interest rate on the loan for 5 years. The benefit to the business in this scenario is that they know exactly what their interest rate will be for the next five years and the banks benefit because they can go out and borrow 5 year funds and make their profit.

I would suggest that in given the economic issues of today to tie a portion of any borrowing to the prime interest rate. The prime rate as of today is 4.5% and unless things drastically turn around I cannot imagine the rates jumping back up. In fact, I think it's reasonable to think that the rates may even drop. Contrast this to the rates on 5 year money right now. If you lock a rate today for five years you will get a rate of 6.25% to 7% depending on your credit worthiness.

Tying a portion of the debt to the prime interest rate may allow you to take advantage of the lower interest rates while tying the bulk of the borrowing to a 5 year rate offers protection on rate increases.

Let's say you are going to borrow $500,000. If I were in that position I would likely borrow $100,000 of the debt with the prime interest rate and the rest tied to a 5 year note. My belief would be that I could aggressively pay down the $100,000 debt as there is very little interest on it while paying the remainder over the 5 years.