TALK is at an all-time high about fixing rates or remaining variable. And there are many traps and different viewpoints.
Some of these include fixing when rates have bottomed-out: they are low and will not increase quickly.
What is your interest rate risk-management strategy? Will you remain variable, fix rates, apply a cap/collar or do nothing which, in itself, could be considered a form of interest-rate risk management? As you dive further into the options, what tools will be used to assist with arriving at a decision? For example, should a five-year average historical financial performance be used to determine maximum cost of funds affordable to the business then compare this to the cost of funds.
Seek data on what the variable rate has done during the past five, 10 or 15 years. How does the decision fit with your business plan, succession plan, changing-of-the-guard or exit from the industry. Ultimately, the decision to fix or remain variable lies with borrower.
Generally speaking, to fix a rate is to make a long-term commitment with the expectation of known-cost of funds.
If a fixed-rate commitment is to be taken out for five years, you should consider seeking a review of your existing banking terms before locking-in?
The importance of this is to ensure the agreed fixed rate is the best your business can achieve before making a long-term commitment.
A good finance broker can assist with establishing the cost of funds an alternative financier may be prepared to provide and, as part of the services, offer a renegotiation option to deal with the existing bank. Consult your adviser or finance broker so they can take you through what is required.
Shifting to a fixed rate may often increase the possibility of discussion around principal repayment. To fix the rate for five years with agreed principal reductions broadens the scope of consideration. Assuming a decision to fixed rate is made, what are the effects on cashflow when agreeing to principal reductions.
A good way to test your business ability to meet these repayments is to simulate a situation whereby you start making a payment, perhaps into a saving account before entering into an agreement.
In other words, practise debt reduction discipline before entering into an agreement. In some instances, the business will evidence savings during a period of time, which provides another means for checking the sustainable level of debt reduction that can safely be applied.
*Full report in Stock Journal, March 14 issue, 2013.