How Government Debt Affects Business Loan Rates

Business loan rates are never dependent on your finances alone. All loans are part of the national credit market, and the strength of that market will partially dictate how cheap or how expensive your financing ultimately is. When the national credit market is weak, the government will often go into debt in order to stimulate the economy. A heavily indebted government will further affect the interest rate you can receive on certain types of loans.

National Prime Interest Rate

The national prime interest rate is set by the Federal Reserve. The Fed is not technically part of the federal government, it maintains sovereignty as an organization that controls money flow and regulates bank-to-bank lending. However, the Fed is heavily connected with the government, and the two will traditionally work together to promote an economic policy.

During a recession, the Fed will typically lower the national prime interest rate to curb inflation. At the same time, the government will be investing money into the lending markets by issuing and guaranteeing loans. The Fed reduces the interest rate in accordance with the government debt in order to attempt to stimulate and still balance the financial markets. Whenever the Fed lowers the national prime rate, you should see lower interest rates on commercial loans to borrowers with good credit. 

Government Loan Guarantees

In further attempts to stimulate the economy, the government may start increasing the amount of loan guarantees it provides. A federal loan guarantee simply means your lender has assurance the government will repay them for a loan if you default. During a recession, the government may be called on to guarantee more loans and pay more on defaults. The government will be amassing debt, but it will do so in the hope more people will borrow money and start growing the economy again.

Small business loans are often a primary method for stimulating the economy. The number of new small businesses is traditionally a strong indicator of economic growth. As a result, even when heavily in debt, the federal government will generally continue to fund and guarantee small business loans.

Government Debt as a National Indicator

The amount of debt at the national level is usually a good indicator to the health of the financial markets. When the government goes further into debt, it is usually because the national GDP was low, not generating enough tax base. It may also be a result of a lot of government stimulus in a recession. In any case, when the government is poor, the banks are typically poor as well.

Poor banks mean less loans and higher interest rates. Banks need cash on hand to provide loans to commercial borrowers. In a recession, they will not only be less likely to fund loans but will be less likely to take on risky borrowers. If your business has a below average credit rating, you will have a much harder time getting a loan in a down economy. You will have to look for alternative methods, such as using collateral, in order to get the funds you are seeking.