What's The Going Rate?

Business Week Crunches the Numbers on Loans

How do you know whether the small-business loan rate offered by your banker is fair? Will rates head lower or higher if you hold out? Those questions loom large when you're shopping for money, but there's no index for small-business loans that tracks the going rate.

Bankers might tell you to watch the prime rate, since it's their benchmark for small-business loans. That's not much help. The prime changes so rarely that there's little movement to track.

A better solution: watch the federal funds rate, which is what big banks pay. We crunched more than 10 years of Federal Reserve data and looked at the "spread," or markup, between the Fed's targeted rate for fed funds and small commercial loans of less than $100,000. We also analyzed the movements of small-business loans with help from Ryan Labs, a New York-based interest-rate specialist.

The result? Markups on small loans over fed funds have remained remarkably consistent over time, and the two rates move almost in lockstep. That's important, because once you know the normal range and the current fed-funds rate--published daily and thus easy to track--you'll know whether your bank is offering a good deal or a gouge job.

The data show that the markup on the smallest commercial loans has averaged 4.22 percentage points since 1986, rarely straying more than half a point in either direction. More recently, the spread stood at just 4.12 points, says Fed first-quarter data released this month, pegging the actual rate at 8.85%, compared with 9.73% a year earlier.

Is that a good deal? Probably, if you look at the historical data. Rates have averaged 9.97% on small loans since 1986, and haven't been this low since 1994. The reason? Intense competition among bankers, who have been reducing their markup to lure you in.

What's the Going Rate?

Could you get a better deal by waiting for your banker to cut his markup again? Maybe. Competition drove the spread as low as 3.5 points in 1989 (and as high as 5.06% in 1992). But there are other moving parts to consider, including the possibility that the fed funds rate will rise and push your rate higher, too. Indeed, the lowest spread occurred around the same time that loan rates were setting an all-time high of 13.39% in 1989.

Remember, these are averages. Every deal is priced on its overall risk, so you can't expect a below-market rate if your company is stumbling. But if your record is clean and the rate seems abnormally high, it'll be your banker who owes you something for a change--an explanation.

Before it's here, it's on the Bloomberg Terminal.